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Article
Publication date: 20 December 2023

Stephen Gray and Arjan Premti

The purpose of this study is to examine how lenders alter their behavior when faced with real earnings management.

87

Abstract

Purpose

The purpose of this study is to examine how lenders alter their behavior when faced with real earnings management.

Design/methodology/approach

This study uses the incremental R-square approach as in Kim and Kross (2005) to examine how much lenders rely on income statement and balance sheet ratios as the degree of real earnings management increases.

Findings

As real earnings management affects mostly the income statement, the authors find that lenders rely less on income statement ratios in making credit decisions in the presence of real earnings management. The authors also find that lenders do not alter their reliance on balance sheet ratios when faced with real earnings management.

Originality/value

This paper is the first to study how lenders alter their reliance on financial statements in making credit decisions in the presence of real earnings management. The findings of this paper could help the regulators set standards to improve the usefulness of financial statements. The findings of this paper could also help practitioners (borrowers and lenders) understand how real earnings management affects credit decisions.

Details

Managerial Finance, vol. 50 no. 5
Type: Research Article
ISSN: 0307-4358

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Article
Publication date: 14 July 2020

Stephen Gray and Arjan Premti

This study examines how lenders modify their behavior and their use of traditional, transaction-based lending models in credit decisions when faced with low earnings quality.

230

Abstract

Purpose

This study examines how lenders modify their behavior and their use of traditional, transaction-based lending models in credit decisions when faced with low earnings quality.

Design/methodology/approach

To measure the earnings quality, following Bharath, Sunder and Sunder (2008), the authors use three measures of accrual quality and combine them into a simple parsimonious measure of accrual quality. Subsequently, the authors apply the incremental R-square approach used by Kim and Kross (2005) to determine the degree to which lenders modify their reliance on financial statement ratios when faced with low accrual quality.

Findings

Consistent with prior literature, this study shows that the cost of debt is higher when accrual quality is low. In addition, this study extends prior literature by showing that lenders decrease their reliance on income statement data to make credit decisions as accrual quality decreases.

Originality/value

This paper broadens existing literature on the pricing of information risk in capital markets by being the first to show that lenders modify their reliance on financial statement data when faced with low-quality accruals. In addition, this paper extends the findings of Billings and Morton (2002) and demonstrates to managers the futility of using accrual manipulations to obtain more favorable credit terms. Lastly, this paper aids regulators and standard setters who seek to improve the usefulness of financial statements by showing that creditors do not appear to be misled by reporting choices that lower the quality of accruals.

Details

Managerial Finance, vol. 47 no. 1
Type: Research Article
ISSN: 0307-4358

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