The Impact of Adopting International Accounting Standards on Private Debt Covenants

Abstract

My thesis examines changes in the use of private debt covenants associated with adopting international accounting standards. Specifically, this thesis examines (1) the impact of mandatory International Financial Reporting Standards (IFRS) adoption on debt covenant violations, (2) the impact of mandatory IFRS adoption on the debt covenant use in late-adopting countries (that adopted IFRS after 2005), and (3) the impact of a single accounting standard adoption (i.e., lease standard) on debt covenant use.

The first study examines whether mandatory adoption of IFRS in 2005 increases debt covenant violations. My study focuses on covenant violation changes and aims to provide more evidence regarding IFRS adoption in debt markets. I find accounting debt covenant violations increase after IFRS adoption in 2005, and this increase is more pronounced in countries with high government effectiveness and high regulatory quality. These results provide new evidence to support the view of reduced contractibility following IFRS adoption.

The second study investigates the impact of mandatory IFRS adoption on debt covenant use in late-adopting countries and IFRS’s long-term (after five years) impact on early-adopting countries (that adopted IFRS in 2005). I find the use of accounting covenants increases in late-adopting countries after IFRS adoption, and this increase only occurs in low-enforcement countries. I also find accounting covenant use in high-enforcement early-adopting countries decreases in the first five years (2005–2010) and becomes insignificant later, whereas, in low-enforcement early-adopting countries, accounting covenant use does not change in the first five years but increases significantly later. My results suggest the level of enforcement plays an important role in determining the use of accounting covenants. I find an insignificant result for the non-accounting covenant use in late-adopting countries.

The third study explores the impact of single standard adoption – ASC 842 – on lessees’ use of debt covenants. I find adopting the new lease accounting standard has an insignificant impact on both accounting and non-accounting covenant use among lessees, indicating that one standard change has a minor impact on debt covenant use. In additional analyses, I test the impact of the COVID-19 pandemic on the use of debt covenants. My results show the use of accounting covenants decreases significantly during the pandemic period.