REAL EARNINGS MANAGEMENT AND LOAN COVENANT VIOLATIONS: ROLE OF ACCOUNTING INFORMATION QUALITY

Abstract

The goal of this paper is to see if the high-quality accounting information can constrain REM from being misused opportunistically, leading to possible loan-covenant violation. The involvement of REM in loan covenant violations and in both account and accounting informativeness has brought a growing academic consideration for this kind of interactions as they influence corporate governance, financial reporting, and creditor protection. Loan covenants are intended to reduce agency problems between borrowers and lenders; yet, as firms approach covenant limits, managers might engage in REM activities, like reducing discretionary spending or changing production decisions, in order to prevent technical default. These behaviours are likely to destroy firm value and impair the decision-usefulness of accounting information. The study followed a quantitative approach and utilized archival financial information of selected public listed companies for ten years. The moderating effect of accounting information quality on the relationship between REM and covenant violation was tested using regression analysis. Findings: The findings indicate that REM has a positive influence on the likelihood of covenant violations, but this effect is weakened when quality of accounting information is high. The results provide guidance to creditors and policymakers interested in managing credit risk and reducing opportunistic behavior, by emphasizing the need for transparency in financial reporting.

Keywords: real earnings management, loan covenants, accounting information quality, financial reporting, creditor protection, opportunism