Financial contracts, opportunism, and disclosure management

Sri S. Sridhar*, Robert P. Magee

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

16 Scopus citations

Abstract

This article shows that if all variables that determine a firm's future cash flows are not contractible, it can be ex ante optimal to design a financial contract that admits debtholders waiving debt covenants on a discretionary basis and firms investing opportunistically subsequent to contracting. Further, as the contractible variable becomes less informative, the contract attaches greater significance to it. Finally, uncertainty in the magnitude of reporting latitude induces aggressive reporting by the firm to avoid violating the covenant or to enhance the chances of a waiver. The debtholders respond by sometimes not allowing the firm to implement mutually beneficial projects.

Original languageEnglish (US)
Pages (from-to)225-258
Number of pages34
JournalReview of Accounting Studies
Volume1
Issue number3
DOIs
StatePublished - Jan 1 1996

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting(all)

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