ACCTG 502 | Session 2 | Does Restricting Managers' Discretion through GAAP Impact the Usefulness of Accounting Information in Debt Contracting? - 2022

LIN CHENG, JACOB JAGGI, SPENCER YOUNG

Introduction: We examine whether limiting managers' discretion through GAAP affects the usefulness of accounting information in debt contracts. Our research offers guidance to standard setters and regulators on how restricting managers' discretion via accounting standards impacts debt contracting. We hypothesize and find that under stricter standards, lenders are more likely to make non-GAAP adjustments to GAAP-based performance measures, suggesting that these restrictions reduce the usefulness of accounting information. We conduct two additional analyses to reinforce our findings. First, in an item-level analysis, we observe a positive relationship between excluding specific nonrecurring items from contractual earnings definitions and the number of restrictions within GAAP standards applicable to each item annually. Second, using difference-in-differences tests around standard changes, we find that the likelihood of excluding certain items increases with greater restrictiveness of related standards. Furthermore, we predict and observe that stricter standards are also positively associated with higher loan spreads, although less so when lenders modify GAAP figures in loan agreements. Overall, this study improves our understanding of how the features of accounting standards influence the relevance of accounting information.