Conservative Financial Reporting, Debt Covenants, and the Agency Costs of Debt

Considerable research has documented the role of debt covenants and conservative financial accounting in addressing agency conflicts between lenders and borrowers. Beatty, Weber and Yu (BWY, 2008) document interesting, but mixed, findings on the relation between debt covenants and conservative accounting, and the extent to which the two contracting mechanisms act as substitutes or complements. In this paper, I discuss the economic roles of financial reporting, debt covenants, and conservatism within the debt contracting environment, and attempt to fit BWY's findings within this context