The impact of IFRS on private debt covenants: international evidence

Abstract

My thesis examines the changes to debt covenants associated with the mandatory adoption of International Financial Reporting Standards (IFRS). I first examine the change in the use of accounting covenants after the mandatory adoption of IFRS. Then I investigate whether other factors such as the differences between local Generally Accepted Accounting Principles (GAAP) and IFRS, and cross-country enforcement differences, can also affect the use of accounting debt covenants. I also examine the use of non-accounting covenants after the mandatory IFRS adoption. The sample I use is new private debt issues between 2001 and 2010 in 18 IFRS-adopting countries (treatment group) and in 16 non-IFRS countries (control group), consisting of 290 and 1,199 firm-year observations for IFRS and non-IFRS countries, respectively. Employing a difference-in-difference specification that controls for firm and debt issue characteristics, I find a significant decline in the use of accounting-based debt covenants in IFRS-adopting countries after IFRS adoption, but not in non-IFRS adopting countries. This reduction is more pronounced in countries with a high level of difference between IFRS and prior local GAAP. In addition, I find that among these high difference countries, the significant decrease only exists in strong enforcement countries. I also find that the use of non-accounting covenants increases after IFRS adoption. My results are robust with respect to a variety of tests. Collectively, the results suggest that the mandatory adoption of IFRS increases the uncertainty and volatility of accounting numbers in debt contracts, and thereby reduces debt contractibility. How extensively local GAAP and IFRS differ is the main reason for the uncertainty that is injected into accounting numbers in debt covenants. In addition, the results suggest that only in those countries with strong enforcement do the effects of IFRS in fact occur. Increased non-accounting covenants use suggests that lenders rely on other kinds of covenants to protect themselves when accounting covenants become less useful. Therefore, the observed reduction in accounting-based debt covenants is not due to increased transparency inherent in IFRS. The results suggest that financial statements prepared under IFRS have potential limitations for debt contracting.