Mandatory IFRS adoption, fair value accounting and accounting information in debt contracts*

Ray Ball The University of Chicago Booth School of Business 5807 South Woodlawn Avenue Chicago, IL 60637-1610 Tel. (773) 834-5941 ray.ball@chicagobooth.edu

Xi Li Fox School of Business Temple University Philadelphia, PA 19122 xili@temple.edu

Lakshmanan Shivakumar London Business School Regents Park London, NW1 4SA United Kingdom lshivakumar@london.edu

Current Draft: 11 September, 2013

We appreciate comments received from Hans Christensen, Valeri Nikolaev, Scott Richardson and participants in workshops at London Business School, Manheim University, Temple University, and University of Michigan, and in the University of Minnesota Empirical Conference. We thank Jose Carabias, Stephanie Markman, and Han-Up Park for research assistance. Ball gratefully acknowledges research support from the University of Chicago, Booth School of Business.

Electronic copy available at: http://ssrn.com/abstract=2278946

Abstract
A significant fall in accounting-based debt covenants and increase in non-accounting covenants follows mandatory IFRS adoption. No such effects are observed in nonadopting countries. Moreover, the changes in covenant usage are associated with measures of the difference between prior domestic GAAP and IFRS, defined in terms of both general and fair value standards. We argue that several aspects of the fair value accounting rules in IFRS are unfavourable to debt contracting. Fair valuing incorporates shocks that are transitory or even reverse before debt maturity, and that would be excluded from covenant definitions (Li, 2010) if not too costly. Fair values also are subjective and manipulable. The IFRS option to fair value the firms own liabilities inhibits leverage covenants, where debts historical face value is relevant. We also argue that accounting covenant use is impacted by the IFRS treatment of convertible debt, method choices given to firms under IFRS, and uncertainty about future IASB rule-making. Overall, IFRS appear to sacrifice debt contracting usefulness for objectives such as complying with an abstract accounting measurement model and incorporating more contemporary information in the financial statements.

Keywords: IFRS, Fair value, Debt covenants, Contracting, Accounting

Electronic copy available at: http://ssrn.com/abstract=2278946

1. Introduction We study the effect on debt contracting of the mandatory adoption of International Financial Reporting Standards (IFRS). Compared to the previous rules in adopting countries, IFRS incorporate a wider range of fair value measurements which, we argue, transformed financial reporting from the perspective of debt contracting. We report that IFRS adoption is associated with a decrease in accounting-based debt covenants and an increase in nonaccounting covenants. The changes in covenant use are related to the difference between IFRS and the debt issuers prior domestic accounting standards generally, and also in the extent to which IFRS contain more fair value accounting than prior domestic standards. We propose several ways in which IFRS financial statements are less useful for debt contracting, four of which involve fair value accounting. First, fair value gains and losses incorporate transitory shocks to assets cash flows, making current earnings a poorer predictor of future debt service capacity. This makes earnings a less efficient contracting variable, particularly for longer-maturity debt (Li, 2010; Christensen and Nikolaev, 2012). Second, fair value gains and losses include shocks to assets expected returns that are expected to reverse in full or in part before debt matures. This makes both balance sheet and earnings variables less efficient in debt contracting, again particularly for longer-maturity debt. Third, many fair value amounts are not derived from arms length prices in infinitely liquid markets, but from subjective estimates ranging from estimated prices in illiquid markets to discounted present values of future cash flows. Agency costs imply managers exploit this subjectivity, which in part explains the traditional use of verifiable historical costs in accounting (Watts and Zimmerman, 1986; Watts 2003). From the viewpoint of

Electronic copy available at: http://ssrn.com/abstract=2278946

lenders, financial statements based on unverifiable estimates made by borrowers would not seem to be an optimal basis for contracting. Fourth, IFRS gives firms the option to fair value certain financial assets and liabilities. This might make some sense from the viewpoint of matching asset and liability measurement bases, but it is inimical to debt contracting. Debt is an agreement to repay principal and interest, and not an agreement to repay fair value. Transferring decision rights to lenders conditional on the borrowers credit risk deteriorating requires leverage covenants that compare asset values with the amount of debt historically incurred, not its fair value. 1 Several additional properties of IFRS introduce uncertainty that is detrimental to debt contracting. IFRS are principles-based and require substantial managerial judgement in their application. Moreover, to gain acceptability across diverse political, economic, institutional, and legal regimes, the IASB has provided managers with substantial choice of accounting methods, creating additional uncertainty as to firms accounting measurements. Uncertainty about future IASB rule-making and uncertainty about the immediate and subsequent effects of IFRS adoption on accounting covenants likely compounded these effects. These uncertainties add risk to borrowers and lenders, including the risk of extreme outcomes such as covenants being tripped by rule changes alone (Deloitte, 2011), and thereby reduce the efficiency of accounting-based covenants relative to alternatives. First-time adoption is a temporary effect. Similarly, uncertainty surrounding rulemaking could be a temporary effect, or it could be a structural property of the IASB rulemaking process. Nevertheless, we conjecture that mandatory IFRS adoption was associated with increased uncertainty about the effects of accounting-based debt covenants.

Similarly, IFRS accounts for convertible bonds by separating the debt and equity components of their issuance price. The purpose of leverage covenants is to trigger effects when the borrowers capacity to repay is impaired, in which case conversion is unlikely and the instrument is almost entirely debt.

While there are several logically feasible debt-contracting responses to IFRS introduction, we argue in the following section that these actions were not chosen voluntarily under the prior accounting regimes, so they would constitute a less efficient mode of accounting-based contracting than previously. We also argue that these responses involve costs, and that some would not be feasible in practice. We test the hypothesis that mandatory adoption of IFRS is associated with a reduction in accounting-based debt covenants, using a sample of new debt issues between 1996 and 2010 in twenty IFRS-adopting countries and eight non-IFRS countries. Using a difference-in-difference specification that controls for firm and debt issue characteristics, we document a significant decline in both the frequency and intensity of accounting-based covenants in IFRS-adopting countries after adoption, but not in other countries. The decline is observed for both income statement covenants and balance sheet covenants. Greater declines in accounting-based covenants are observed in countries whose pre-IFRS domestic standards differed more from IFRS, and in countries where the difference involved fair value accounting. The results are robust with respect to a variety of specifications. A possible alternative explanation for the post-IFRS decline in accounting covenants is that IFRS adoption and correlated regulatory changes improved financial transparency, and this reduced the demand for covenants. We are sceptical of this argument. While increased transparency could improve debt pricing in both primary and secondary markets, it would not per se reduce the demand for covenants that transfer decision rights to lenders when violated. Furthermore, we report two pieces of evidence that do not support this explanation. First, the post-IFRS decline in accounting-based covenants is unrelated to country-level measures of enforcement. Second, accounting covenants tend to be replaced by non-accounting covenants, indicating substitution among (but not reduced demand for) covenants. 3

This paper contributes to the literature on economic consequences of IFRS adoption. To date, studies generally have addressed the equity market and concluded that mandatory IFRS adoption is beneficial in that context (e.g., Barth, Landsman, and Lang, 2008; Daske, Hail, Leuz, and Verdi, 2008; Armstrong, Barth, Jagolinzer, and Riedl, 2010; Kim, Tsui, and Yi, 2011; Landsman, Maydew, and Thornock, 2012). Our evidence suggests a different result for debt contracting, that financial statements under IFRS are less useful for covenant design. This constitutes a market test of fair value accounting under IFRS, analogous to Christensen and Nikolaev (2013). The paper also contributes to the literature on the use of accounting information in debt contracting. Several studies have documented that properties of accounting numbers influence their use in debt contracts. For example, Nikolaev (2010) finds evidence that accounting covenant use is associated with the degree of timely loss recognition. Costello and Wittenberg-Moerman (2011) find that accounting-based covenant use falls when internal control weaknesses impede financial statement reliability. Our study is related to the seminal Leftwich (1983) study of non-GAAP contracting in private loan agreements, to the recent Demerjian (2011) evidence that increased fair value accounting in the U.S. has eroded the use of balance sheet based debt covenants, and also to Christensen and Nikolaev (2012). There are several potential policy implications. The contrasting results for debt and equity users challenge the rationale for general purpose accounting standards. The joint IASB/FASB Conceptual Framework project (FASB, 2010, OB2) views investors, lenders, and other creditors and decisions involving buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit as homogeneous. Our arguments and results imply that for debt contracting purposes it is not optimal to use a consistent accounting measurement model for all assets and liabilities, as apparently favoured 4

by IASB and FASB, and advocated by researchers ranging from Chambers (1966) to Barth (2013). They also highlight the distinction between recognition and disclosure, of fair values in particular, since debt contracting is on the basis of the recognized amounts alone. While it is not in our sample, the policy implications apply to the U.S. as well. U.S. GAAP has adopted rules that are similar or equivalent to IFRS gradually over several decades, more recently under a policy of ultimate convergence.2 Consequently, the effects of the U.S. adopting these rules are dissipated over time and are difficult to identify against background events. An advantage of our research design is that IFRS adoption occurs relatively abruptly in our sample countries. In addition, we can exploit measures of the extent to which countries prior domestic standards differed from IFRS, both generally and in relation to fair value accounting. The results potentially provide insight into the more dissipated effects of the U.S. adopting similar or equivalent rules to IFRS over time. We hasten to add that our arguments and our results do not imply that either IFRS or fair value accounting should be abandoned. Our more modest conclusion is that IFRS and fair value accounting have important limitations for debt contracting purposes, the unique properties of which do not appear to be reflected in the accounting standards. We also acknowledge that, while both univariate and difference-in-difference analyses indicate a decline in accounting covenant use after IFRS adoption, the result could have occurred due to variables for which we have not controlled. Nonetheless, our evidence raises the bar for those claiming that IFRS or fair value accounting is in some sense ideal. The remainder of the paper is organized as follows. Section 2 develops testable hypotheses. Section 3 describes the data and sample selection. Section 4 discusses results. Section 5 discusses the results for additional analyses. Section 6 provides conclusions.
FASB (2013) indicates the convergence process began as early as 1999, was formalized in the Norwalk Agreement with IASB, and involved a joint commitment to using more fair value accounting.
2

2. Hypotheses
The adoption of IFRS in many jurisdictions heralded radical changes in their accounting rules and in the properties of financial statements prepared under the new rules. This section outlines several ways in which, we conjecture, the changes adversely affected the use of accounting-based covenants in debt contracting. 2.1 IFRS, fair value accounting, and debt contracting IFRS adoption brings a strong tilt toward fair value accounting. The IASB has replaced many traditional historical cost accounting methods with rules that measure assets and liabilities at their fair values (Ernst and Young, 2005; Ball, 2006). Fair value measurements are incorporated in IAS 16 (Property, Plant and Equipment), IAS 22 or IFRS 3 (Business Combinations), IAS 36 (Impairment of Assets), IAS 37 (Provisions, Contingent Liabilities and Contingent Assets), IAS 38 (Intangible Assets), IAS 39 or IFRS 9 (Financial Instruments: Recognition and Measurement), IAS 40 (Investment Property), IAS 41 (Agriculture), IFRS 2 (Share-based Payment), IFRS 4 (Insurance Contracts), IFRS 5 (Noncurrent Assets Held for Sale and Discontinued Operations), and IFRS 13 (Fair Value

Measurement). Fair value is defined as: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (IFRS 13, Appendix). Fair value accounting apparently is founded on premises that all users can make more informed decisions if (1) the basis of measurement for all assets and liabilities is consistent (FASB, 2006 P4; FASB, 2008 P4) and (2) that basis is a measure of current market value. This accords with, and possibly has been strongly influenced by, the classical accounting literature (e.g., Chambers, 1966). This literature was developed prior to the emergence of 6

costly contracting theory, which subsequently has transformed economic thought.3 It provides no role for contracting on the basis of financial statement information, and for debt contracting in particular. Thus, in the conceptual framework the IASB and FASB developed jointly (FASB, 2006, 2008, 2010), there is no reference of any sort to users contracting on the basis of the financial statements. While on the surface this framework appears to be directed to the information needs of users, it sketches a supply-focused model of financial reporting. The supply-based approach is exemplified by the IFRS 9 option to fair value certain of a firms own liabilities, with the objective of better matching the measurement bases of assets and liabilities (KPMG, 2010, p.7). This might make sense in the context of an abstract accounting model that requires consistent measurement methods for all balance sheet quantities and does not incorporate the uses to which financial statements are put. However, it ignores the fact that debt contracts inherently imply matching assets with the face value of debt, as measured by the amortized historical cost model. In other words, this IFRS standard appears to be based on a supply-driven model of accounting that does not take salient demand characteristics into consideration. It is not unreasonable to conclude that IFRS have not been developed with costly contracting in mind, including debt contracting. In this section, we describe some of the potential shortcomings of IFRS from a debt contracting perspective, and discuss the costs and feasibility of attempting to contract around those shortcomings. 2.1.1 Effect of transitory fair value components on income-based covenants Many IFRS standards require changes in the fair values of certain assets and liabilities to be reflected in the income statement as unrealized gains or losses. For instance, IFRS

Also known as transaction cost economics, its origins lie in Knight (1921), Commons (1931), Coase (1937, 1960) and Debreu (1959). The area later was transformed by Ross (1973), Jensen and Meckling (1976), Holmstrm (1979, 1982), and Williamson (1979, 1981), among many others.

earnings incorporate gains and losses on investments held for trading purposes (IAS 39), on biological assets such as animals and crops (IAS 41), on financial instruments (IAS 39, IFRS 9) and, if the option to fair value is chosen, on property, plant and equipment (IAS 16), investment property (IAS 40), and the firms own qualifying liabilities (IAS 39). To the extent that assets fair value gains and losses are due to shocks to expected future cash flows, they are transitory (shocks to discount rates are discussed below) and large (they are capitalized rather than flow quantities). We therefore expect IFRS to incorporate substantial transitory components into earnings. Consistent with this expectation, Hung and Subramanyam (2007) report that, for German voluntary IFRS adopters, IFRS earnings are more volatile and transitory than previously reported under domestic German standards. A central role of debt covenants is to act as ex-post trip wires that transfer decision rights to lenders in states characterized by poor economic performance. We argue that an earnings variable that incorporates transitory components is a less efficient predictor of future debt service capacity and hence a less efficient contracting variable for transferring decision rights to lenders in adverse future states (Li, 2010; Christensen and Nikolaev, 2012). Consider the following example. A firm acquires assets costing $1000 that generate a perpetual earnings and free cash flow stream of $100 per period. The discount rate is 10%, so the fair value of the assets also is $1000. The assets are financed 40% by perpetual debt paying 5%. At the beginning of a subsequent period, an adverse shock of -$10 occurs to the cash flow stream. The discount rate is unchanged, so the new fair value of the assets falls to $900. Future free cash flow of $90 is ample to service periodic interest payments of $20, yet current-period earnings is -$10 ($90 less a fair value loss of $100). This illustrates how contracting on an earnings variable inclusive of large capitalized fair value losses can trigger earnings-based covenants even when debt service is not materially affected. Symmetrically, a 8

positive shock to fair value, when capitalized and incorporated in earnings, also makes current-period earnings a less efficient predictor of future debt service capacity. One response to mandatory IFRS incorporating more fair value gains and losses in earnings would be to substitute balance sheet covenants for income statement covenants, since asset values are not transitive and fair valuing most likely improves balance sheet predictive power. However, balance sheet covenants were not chosen voluntarily under the prior accounting regimes, so they presumably provide a less efficient mode of contracting than previously. For example, firms with substantial unrecorded intangible assets might otherwise have found it more efficient to contract on earnings/debt rather than earnings/assets ratios. Furthermore, in following subsections we argue that the usefulness of balance sheets in debt contracting is impaired by other properties of fair value accounting. An alternative response would be to contract on the basis of pre-IFRS domestic standards (frozen GAAP). This would become increasingly problematic over time as the domestic standards become outdated, so a more efficient response might be to contract only out of particular IFRS standards. This would incur the costs of preparing and auditing parallel sets of financial statements, and of maintaining old accounting and audit processes. Consistent with transitory components rendering earnings a less efficient variable for debt contracting, Li (2010) shows that borrowers and lenders tend to contract on an earnings variable that excludes extraordinary items such as gains and losses on discontinued operations, particularly for longer-maturity debt. However, Li (2010) studies a context in which GAAP requires firms to report the information needed to contract around transitory earnings components, and hence the information is independently audited and essentially costlessly available to users. This is not the case with many fair value gains and losses, so borrowers would incur the costs of keeping parallel books and having them audited. 9

Firms that elect to fair value property, plant and equipment under IAS 16 record gains and losses due to transitory shocks. If a shock is positive, under IAS 16 39 it is incorporated in Other Comprehensive Income, not current-period Net Income, unless it is a reversal of a prior loss (in which case it is booked in Net Income). If a shock is negative, IAS 16 40 incorporates it in current-period Net Income, unless it is a reversal of a prior gain (in which case it is booked in Other Comprehensive Income). If disclosed, for balance sheet covenants the shock can be contracted around at low cost by backing out the revaluation reserve. However, the depreciation charge against future earnings is based on the revalued amount of the asset, and backing out the effect on current earnings of all past capitalized transitory gains would be a complex calculation for users to perform themselves, even for a single asset. It would require information about the assets entire history of booked gain and losses and a recalculated depreciation schedule. A contractual formula to implement this calculation for a firm with thousands of assets would be complex and costly to implement. Consequently, excluding many transitory fair value gains and losses from earnings by contractual formula is not feasible, so borrowers would need to prepare parallel audited financial statements or to contract on balance sheet ratios or on EBITDA or cash flow ratios.4 Similar arguments apply to other fair value standards, including IAS 41 on biological assets. Fair value accounting also introduces debt-irrelevant earnings volatility through changes in the fair values of assets that essentially hedge existing liabilities, but do not quality for hedge accounting. Changes in fair values of the liabilities then impact earnings later than those of the underlying assets, whereas under historical cost accounting they would be matched at realization.

This helps explain the Christensen and Nikolaev (2013) result that few firms exercise the IAS 16 fair value option for property, plant and equipment.

10

We conclude that fair value accounting incorporates transitory components in income statement numbers, thereby reducing the usefulness of these numbers for predicting the ability of the borrower to service future debt obligations.5 Contracting around this limitation incurs increased costs under IFRS, so we predict that mandatory IFRS adoption is associated with a decrease in income statement based covenants. 2.1.2 Effect of discount rate shocks on income and balance sheet covenants Fair value gains and losses also originate in shocks to discount rates (expected returns). While cash flow shocks are transitory, the effects of shocks to expected returns on fair values are expected to reverse over asset lives. For example, if an assets fair value increases due to an unanticipated fall in discount rates, then the fair value gain is expected to be offset by lower future returns. To the extent that fair value reversion is expected before debt matures, the shock is irrelevant for predicting future debt service capacity and hence for debt contracting because it does not reflect a change in the expected cash available for debt servicing. This is the case with standards addressing short-term assets such as traded

financial instruments (IAS 39, IFRS 9), which are more relevant for short-term loans. The problem also applies to any asset or liability that is fair valued at current market price, at estimate of current market price, or at present value of cash flows using a current discount rate. The expected fair value reversion makes both book value and accounting income a poorer predictor of the cash flow that the asset is expected to produce during the life of the debt contract, and thus a poorer indicator of capacity to meet debt payments.

Covenants based on volatile accounting numbers also could be dropped if they induce managers to take suboptimal risk positions. Lins, Servaes, and Tamayo (2011) document that several firms changed risk management policies when required to fair value their derivatives under SFAS 133 and IAS 39, and that changes were more likely when accounting numbers were used in contracting. DeFond, Hung, Li, and Li (2011) conclude that mandatory IFRS adoption increases the crash risk of banks, which they attribute to increased earnings volatility under fair value accounting.

11

The problem also applies to asset impairment standards. IAS 36 56 specifies that the discount rate used for fair value impairment measurement is the current market rate. The issue from a debt contracting perspective is that part or all of any impairment due to an increase in discount rates is expected to reverse before the debt matures. If the maturity of an impaired asset is less than that of the debt, the fair value reduction is expected to completely reverse before debt maturity. It would be less efficient to contract on a leverage covenant that could be violated due to discount rate shocks which do not affect debt service capacity. While asset impairment is a source of conditionally conservative accounting and likely contributes to efficient debt contracting, failure to separate discount rate shocks from cash flow shocks potentially hinders efficiency, particularly for longer-maturity debt.6 2.1.3 Subjectivity in measurement of fair values Fair value accounting uses prices in actively traded markets if available. If liquid market prices are not available, as generally is the case with longer-term assets in particular, fair values are based on subjective estimates derived from valuation comparables, pricing models, discounted future cash flow estimates, and other techniques. Agency costs imply managers have the potential and incentives to exploit the subjectivity of these estimates (Watts and Zimmerman, 1986; Watts, 2003). Nevertheless, the IASB and FASB joint conceptual framework (IASB, 2010) pays scant attention to verifiability. It views relevance and faithful representation as the fundamental qualitative characteristics of accounting information (QC5), and these are merely enhanced by verifiability (QC4). It elaborates (QC28):

The comparable U.S. standard (SFAS 121 and SFAS 142) triggers impairment based on undiscounted cash flows. If triggered, impairment is to fair value calculated at the current discount rate. This inconsistency seems nonsensical from an abstract accounting measurement model perspective, but makes more sense from a debt contracting perspective.

12

It may not be possible to verify some explanations and forward-looking financial information until a future period, if at all. To help users decide whether they want to use that information, it normally would be necessary to disclose the underlying assumptions, the methods of compiling the information, and other factors and circumstances that support the information. An FASB staff member explained this joint choice as follows (FASB, 2005): The Board has required greater use of fair value measurements in financial statements because it perceives that information as more relevant to investors and creditors than historical cost information. . In that regard, the Board does not accept the view that reliability should outweigh relevance for financial statement measures. Due to severe information asymmetry between borrowers and lenders concerning the borrowers credit risk, we expect the verifiability of accounting measurements to be especially important in the context of debt contracting. Relative to shareholders, debtholders can be expected to have a stronger preference for verifiability over informativeness, especially for good news (e.g., Watts, 2003; Ball, Robin, and Sadka, 2008), which in part explains the traditional use of conservative historical cost accounting. From the viewpoint of lenders, financial statements based on unverifiable estimates made by borrowers would not seem to be an optimal basis for contracting. This provides an additional reason to expect that IFRS adoption has a negative impact on the use of accounting-based debt covenants. 2.1.4 Option to fair value debt IAS 39 (revised slightly in IFRS 9) provides firms with an option to fair value certain of their own liabilities. This does not appear to be optimal from the viewpoint of debt contracting, the fundamental reason being that debt is an agreement to repay principal and interest, not to repay fair value. Leverage covenants transfer some decision rights to lenders when the borrowers credit risk deteriorates and its ability to service its debt obligations falls. These might include veto rights on major financing and investment transactions, including dividends and share 13

repurchases. Covenant violation also might trigger debt repricing, or the right to be repaid. Leverage covenants based on balance sheet data involve comparing asset values with the amount of outstanding debt obligations, not with debt fair values. A disadvantage of the fair value method is that it reduces the balance sheet amount of debt in tandem with the ability of the borrower to service it. Consider a simple example with risk neutral investors requiring an expected return r. A single-asset firm generates risky future cash flow A(1+r)/(1-p) with probability (1-p), and zero otherwise. The firm is financed by debt promising to pay principal D and an interest coupon rate of (1+r)/(1-p) -1. The probability of default on these payments is p. Because the expected value of the principal and interest payments is D(1+r), the debt is issued at par value D. At issuance, the balance sheet therefore shows a proportion d=D/A of debt finance. Immediately after issuance, the default probability rises to p > p. The fair values of the asset and liability fall in tandem to A(1-p)/(1-p) and D(1-p)/(1-p) respectively. A fair valued balance sheet then records an unchanged debt proportion d, independent of the post-issuance default probability, and thus is useless as a mechanism for triggering transfer of decision rights to lenders when the borrowers credit risk deteriorates. The above is a simplified illustration of how fair valuing liabilities reduces, and in the limit completely eliminates, the effectiveness of balance sheet leverage covenants. While it might provide better matching of asset and liability measurement bases, to comply with an abstract accounting measurement model, that model does not incorporate debt contracting and consequently ignores the fact that debt contracts inherently require mis-matched measurement bases for assets and debt. In contrast, the amortized historical cost method measures the present value of the principal and interest amounts contractually owed to

14

lenders, calculated at the historical borrowing rate, and thus it provides a current measure of the firms debt obligations. An additional problem can arise when borrowers have substantial unrecorded assets. Consider a firm whose credit is downgraded due to a fall in customer demand or other event that reduces enterprise value but is not recognized on the balance sheet. The fair value of liabilities decreases, but there is no offsetting decrease in fair value of assets, perversely causing balance sheet leverage to decline. A similar issue arises for bonds with an attached option to convert to equity exercisable by lenders. IFRS 9 (previously, IAS 32 and IAS 39) requires the separate components of the issuance price to be valued and recorded as debt and equity. The option is unlikely to be exercised in the event of default, when the full amount of the debt is repayable, not just the value of the non-equity component at issuance. Feasible responses by borrowers and lenders would be to substitute income statement covenants, to contract on frozen GAAP, to contract on a private set of financial statements that do not fair value liabilities, or (in the case of convertibles) to define debt as including their equity component. However, we argue above that the efficiency of these options in debt contracting is impaired by other factors. Another response would be to contract out of fair valuing liabilities. This would deny the borrower the IAS 39 option to fair value assets and liabilities that do not qualify for hedge accounting, and the resulting accounting mismatches could induce volatility in income statement and balance sheet ratios. All of these responses induce costs of some sort, so we predict that mandatory IFRS adoption is associated with a decrease in balance sheet covenants.7

In addition, to price risky debt in primary and secondary markets, users need to know historical costs (strike prices), but not fair values (which for pricing purposes are the dependent variable).

15

2.2 Debt contracting and other properties of IFRS This subsection outlines several sources of uncertainty arising from IFRS adoption that, we propose, inhibit efficient debt contracting. 2.2.1 Uncertainty due to discretion over method choice IFRS provide managers with substantial choice of accounting methods, apparently to gain acceptability in a wide range of regimes. For instance, IAS 40 allows firms to report investment property at either fair value or historical cost. Similarly, IAS 19 gives firms the option to recognize actuarial gains and losses on post-retirement employee benefits fully in the income statement or in the statement of comprehensive income, or to partly defer recognition over time using the corridor approach.8 To lenders, this creates both uncertain effects on accounting based covenants, as well as risk of managerial opportunism. 2.2.2 Uncertainty due to discretion over method implementation IFRS are principles-based rules that lay down broad rather than specific requirements and thus require more management judgement in application. To the lender, this creates additional uncertainty over the effect of IFRS on accounting covenants, and risk of managerial opportunism. 2.2.3 Uncertainty about future IASB rule-making We conjecture that uncertainty about future IASB rule-making added further uncertainty to the effect of IFRS on accounting covenants. The IASB made frequent changes to IFRS prior to adoption by many countries in 2005. Figure 1 plots the number of new standards or amendments to existing standards by year from 1997 to 2012. Changes made simultaneously to multiple existing standards as a consequence of the issuance of a new standard are treated as a single change. The frequency of published changes to IFRS
The European Commission (2008) reports that, among IFRS-adopting European firms, the choice of accounting for post-retirement employee benefits varies across industries and countries.
8

16

standards substantially increased after the European Unions (EU) 2002 commitment to adopt them for publicly-listed firms and after the actual adoption in 2005. In addition, borrowers and lenders face uncertainty about the adoption or modification of individual IFRS standards in their jurisdictions, the EU in particular. Frequent revision could be a temporary phenomenon associated with the development and adoption of the first complete set of IFRS standards in many jurisdictions. Alternatively, it could be a structural property of the IASB rule-making process and multi-jurisdictional adoption. The IASB is subject to a wider range of economic and political influences than any individual countrys standard setting body, so it is reasonable to expect greater uncertainty about its future actions. Only time will tell. 2.2.4 Uncertain first-time adoption and subsequent effects The IASB issued IFRS 1 (First-time Adoption of International Financial Reporting Standards) in June 2003. The standard requires firms reporting for the first time under IFRS to thoroughly revise their balance sheets prepared under prior domestic rules. This involves adding, deleting, and remeasuring assets and liabilities to comply with IFRS. Christensen, Lee, and Walker (2009) argue that IFRS introduction consequently transferred wealth between debt and equity investors. Subsequent to first-time adoption, income statements and balance sheets are reported under IFRS, not prior domestic rules. We argue that, prior to introduction, the first-time and subsequent effects of IFRS on covenanted accounting ratios, and any attendant wealth transfers, would have been uncertain. This would have constituted risk to both borrowers and lenders, including the risk of covenants being tripped by rule changes alone. Subsequent to adoption, experience with IFRS is likely to have reduced uncertainty about its effects on accounting covenants, but it is unclear how long this uncertainty would have persisted. We 17

conclude that at least temporary and possibly lingering uncertainty to borrowers and lenders using accounting covenants surrounded IFRS introduction, thereby reducing their use. The IASBs governing body acknowledged this issue (IASC Foundation 2002, 22): The IASB has no general policy of exempting transactions occurring before a specific date from the requirements of new financial reporting standards. When financial statements are used to monitor compliance with contracts and agreements, a new Standard may have consequences that were not foreseen when the contract or agreement was finalised. For example, covenants contained in banking and loan agreements may impose limits on measures shown in a borrowers financial statements. The IASB believes the fact that financial reporting requirements evolve and change over time is well understood and would be known to the parties when they entered into the agreement. It is up to the parties to determine whether the agreement should be insulated from the effects of a future accounting standard, or, if not, the manner in which it might be renegotiated to reflect changes in reporting rather than changes in the underlying financial position. No mention is made of renegotiation costs, which are substantial in the case of public debt. Changes to accounting rules (and even changes to terminology) can impose covenant renegotiation costs, redrafting costs, and legal fees.9 2.2.5 Summary Uncertain future accounting rules and uncertain effects add risk to both borrowers and lenders, including covenants being tripped by rule changes alone, thereby reducing the efficiency of accounting-based covenants relative to alternatives. We conjecture that these effects cause borrowers and lenders to reduce accounting-based covenants. 2.3 Costs of contracting around IFRS standards It is logically possible for borrowing firms and lenders to contract around these problems. Logically, they could contract on the basis of pro-forma financial statements prepared under their countrys pre-IFRS rules (frozen GAAP), or prepared without applying specific IFRS standards such as IAS 39 on financial assets and liabilities or specific
For example, IFRS requires separate disclosure of material items but does not refer to U.K. GAAPs exceptional items or provide an equivalent label. U.K. firms debt covenants that exclude exceptional items (Li, 2010) would require redrafting under IFRS.
9

18

parts of an IFRS standard such as fair valuing financial liabilities. All such adjustments involve costs that did not exist prior to mandatory IFRS adoption, and render accountingbased covenants less efficient relative to alternatives than they were prior to adoption.10 We noted above that, in contrast to the context studied by Li (2010), the information needed to contract around many fair value measurements is not reported in the financial statements and hence is not costlessly available to users. Borrowers would need to incur the costs of keeping parallel books and having them audited. Consistent with this, we observe frozen GAAP in 1% of cases of in a hand-collected sample, details of which are described in Section 5.10. Moreover, in this sample, we also rarely observe any adjustments to covenants for fair value accounting. Consequently, we expect a substitution away from accounting-based covenants in favour of alternatives. 2.4 Effect of possible improved transparency under IFRS The arguments in the previous sub-sections lead us to the unambiguous expectation that both income statement and balance sheet covenants would decline under IFRS, due to both its emphasis on fair value reporting as well as due to the frequent changes to IFRS standards. However, IFRS could also affect debt covenants through its effect on firms financial transparency, although the effect of financial transparency on debt covenants is ambiguous as discussed below. IFRS often is viewed as significantly improving financial transparency. Moreover, the increased reporting of fair values under IFRS increases the information content of financial statements, which could potentially make the IFRS adoption lead to greater accounting covenant use. These arguments are supported by the findings in Wu and Zhang (2009) and
10

Kvaal and Nobes (2010) report that, when allowed under IFRS, many firms continue to use their countrys pre-adoption domestic standards. This is consistent with firms attempting to reduce IFRS adoption costs.

19

Ozkan, Singer, and You (2012) that firms rely more on accounting earnings to make internal evaluation decisions. However, the theoretical model in Demerjian (2012) suggests that the demand for covenants will decrease when financial transparency improves and lenders have clearer information about the borrowers. Demerjian (2012) presents a model where lenders face uncertainty about borrowers prior to contracting and shows that borrowers can mitigate this concern by allowing lenders to use covenants as trip-wires that allow lenders to renegotiate in the future when new information is received. In his model, the need for covenants is lowered when information uncertainty is reduced through higher-quality financial reporting. Along similar lines, Kim, Tsui, and Yi (2011) argue that banks are less likely to impose covenants on borrowers using IFRS than those using domestic GAAP, because greater financial transparency of IFRS reduces the demand for ex-post monitoring and recontracting. They find support for their arguments in a sample of voluntary IFRS adopters. Thus the effect of IFRS adoption on the use of accounting numbers in debt contracting is ambiguous. 2.5 Hypothesis The above arguments lead us to the following hypothesis: H1: Accounting-based covenant use in debt contracts falls after IFRS adoption.

3. Data and Sample Selection

Our primary data set combines multiple sources to compile a relatively large sample of new debt issues made between 1996 and 2010 by firms in 28 countries. The information on public bond issuance is obtained from Mergent FISD, Capital IQ, SDC Thomson One, and Bloomberg. The information on private loan issuance is obtained from DealScan and

20

SDC Thomson One.11 We match borrowers from these databases with Compustat Global data using available company identifiers provided by Excel Company ID, Cusip, Sedol, ISIN, Ticker, and CIK. For borrowers that cannot be matched by these identifiers, we manually match by borrower name and country.12 We merge each debt issue with the borrowers accounting information on Compustat Global in the fiscal year immediately before the issuance date. Countries that mandated IFRS in 2005 are the treatment sample. Following Landsman, Maydew, and Thornock (2012), countries that retained their domestic accounting standards during the sample period are the control sample.13 U.S. firms are excluded from the control group because they attract more coverage by the data vendors, their disproportionate representation could unduly influence the results, and because the IASB/FASB convergence project pollutes the U.S. as a control.14 We require non-missing information on issue date, debt amount, yield spread, covenants, and maturity. We exclude debt issues with no covenants recorded by the data providers.15 This results in a sample of 5,134 debt issues. We further exclude firm-year

11

To construct the bond sample, we start with Mergent FISD and augment the dataset with (in order) Capital IQ, Bloomberg, and SDC, taking care to exclude duplication. To construct the loan sample, we start with DealScan and augment the dataset with SDC, again excluding duplication. Consistent with prior literature, we consider each loan facility as a separate observation, because loan features, such as yield spread, maturity, and offering amount, vary across facilities (Qian and Strahan, 2007; Kim, Tsui, and Yi, 2011). When excluding duplicate observations, if different data sources provide different numbers of accounting covenants, we keep the data source with the highest number to mitigate the concern that a particular data provider may understate covenant intensity. For example, Nini, Smith, and Sufi (2009) observe that DealScan under-reports the use of capital expenditure restrictions in loan contracts. 12 For borrowers in Mergent FISD, we use Cusip, Sedol, Ticker, and borrower name and country for matching. For borrowers in Capital IQ, we use the Excel Company ID-Gvkey link table provided by Capital IQ. For borrowers in SDC, we use CIK, Cusip, Sedol, and borrower name and country for matching. For borrowers in Bloomberg, we use ISIN for matching. For borrowers in DealScan, we manually match by borrower name and country. 13 The sample period in Landsman, Maydew, and Thornock (2012) ends in 2007. To make sure that there is no shift in the accounting regime after 2007 in our control sample, we manually check updates on each countrys accounting standards from the IAS Plus website at www.iasplus.com. New Zealand adopted IFRS in 2007 and therefore has been excluded from the control sample. 14 We ignore any pre-IFRS convergence of countries standards to IFRS, possibly under-estimating the true effects of IFRS adoption. 15 Only 10% of international debt issues have at least one recorded covenant. We exclude the remainder because our data providers suggest this is likely to be caused by them failing to collect covenant information, rather than

21

observations in the control sample of non-IFRS countries that voluntarily used IFRS (10 observations). We also exclude firm-years in the treatment sample of IFRS-adopting countries that did not use IFRS for fiscal years ending in or after December, 2005 (173 observations) or did not use local accounting standards previously (252 observations).16 We exclude firm-years that do not disclose the accounting standards used (14 observations). Further, following Qian and Strahan (2007) and Kim, Tsui, and Yi (2011), we exclude debt issued by firms in financial industries (SIC 6), as these firms face different regulatory, financial reporting, and debt contracting issues. Lastly, we drop observations that do not have enough data to calculate the variables used in our regressions. The final sample comprises 3,037 observations, including 1,362 debt issues from 20 IFRS adoption countries (treatment sample) and 1,675 debt issues from eight non-IFRS adoption countries (control sample). A potential concern is that our results could be due to an unobservable change in the way the data providers cover debt issues or classify covenants. This seems unlikely, since (for it to show up in our diff-in-diff tests) the change would need to occur at the time of IFRS adoption, in IFRS-adopting countries but not in non-adopting counties, and independent of the firm, industry, and debt issue characteristics for which we control. We also report results from a secondary sample constructed from hand-collected prospectus data for 758 public bond issues, 616 of which are in IFRS countries and 142 are in non-IFRS countries. It is less representative than the primary sample, in that private loan agreements are not publicly available for non-U.S. firms, but produces similar results.

covenant-free debt. Excluding issues without covenants also is consistent with prior literature (e.g., Demerjian, 2011; Christensen and Nikolaev, 2012). While this excludes debt issues that actually are covenant-free, our data providers and extant research suggest that covenant-free debt was relatively rare during the sample period. 16 Firms in the treatment sample that do not use IFRS after the mandatory adoption date might be exempted, for example being allowed to follow U.S. GAAP. These observations are removed to create a cleaner comparison between local GAAP in pre-adoption period and IFRS in post-adoption period.

22

Table 1 reports the distribution of the primary sample of debt issues by country. Within the treatment group, 52% of the observations are from the U.K. and France, while within the control group, 63% of the observations are from Japan and Taiwan.

4. Empirical Research Design and Results

4.1 Accounting covenant use pre- and post-IFRS (H1) We use the following difference-in-difference models to examine the change in accounting covenant use around mandatory IFRS adoption, where debt issued in non-IFRS mandation countries is the control sample: Pr(D_ACov=1) = 1 Post+ 2 IFRS+ 3 PostIFRS +Control Variables Log(1+Num_ACov) = 1 Post+ 2 IFRS+ 3 PostIFRS +Control Variables (1) (2)

Post is a dummy variable equal to one for fiscal years ending in or after December, 2005. IFRS is a dummy variable indicating that the debt is issued by a firm in an IFRS-mandating country. D_ACov and Num_ACov measure accounting covenant use. Equation (1) is a Probit model examining the frequency of including accounting covenants in debt contracts. D_ACov is a dummy variable defined as one if the debt contract contains at least one accountingbased covenant, and zero otherwise.17 Equation (2) is an OLS model examining the intensity of accounting covenant use. Num_ACov is the logarithm of one plus the count of the total number of accounting-based covenants.18 In both models, a negative (positive) 3 indicates a decline (increase) in the use of accounting covenants after mandatory IFRS adoption.19

17

For public bonds, we follow Nikolaev (2010) and identify declining net worth, indebtedness, leverage test, maintenance net worth, net earnings test, and fixed charge coverage covenants as accounting-based. For private loans, we follow Demerjian (2011) and Christensen and Nikolaev (2012) and identify interest coverage, fixed charge coverage, debt-to-earnings, leverage, net worth, and current ratio covenants as accounting-based. 18 The log transformation is consistent with prior literature such as Becker and Strmberg (2012). 19 We do not predict the sign of 1 or 2, as there is no prior literature on the determinants of accounting covenant use in a cross-country setting.

23

The above specification does not allow the regression coefficients on control variables to differ across treatment and control countries and/or across different time periods. To control for the effects of institutional differences across IFRS and non-IFRS countries as well as for the effects of changes in firm-level measures upon IFRS adoption, we extended the specification to allow the regression coefficients to vary both between IFRS and nonIFRS countries as well as between pre- and post-IFRS periods. These modifications leave our conclusions unchanged (results untabulated). We further classify accounting covenants into those based on income statement numbers, such as debt-to-earnings, interest coverage, and fixed charge coverage covenants, and those based on balance sheet numbers, such as indebtedness, current ratio, leverage, and net worth covenants. The classifications are mutually exclusive. Although a debt-to-earnings covenant employs both income statement and balance sheet numbers, we classify it as an income statement covenant following prior literature (Demerjian, 2011; Christensen and Nikolaev, 2012). D_ACov_IS is a dummy variable indicating that the debt contract contains at least one income statement covenant. Num_ACov_IS is the total number of income statement covenants. D_ACov_BS is a dummy variable indicating that the debt contract contains at least one balance sheet covenant. Num_ACov_BS is the total number of balance sheet covenants. We control for firm, debt, industry, and country characteristics that might shape the use of accounting covenants in debt contracts. Because smaller firms, higher-growth firms, as well as those with fewer tangible assets and lower profitability face higher agency costs of debt and hence greater demand for covenants, we control for firm size (logarithm of market value of equity), market-to-book ratio (market value of equity divided by book value of equity), asset tangibility (net PP&E divided by total assets), and profitability (EBITDA 24

divided by total assets). We also include leverage (total debt divided by total assets) as a control variable, since leverage could exacerbate the agency cost of debt. However, leverage could also reflect the firm having other debt contracts with covenants and prior lending relationships, which could reduce the need for debt covenants in newly issued debt.20 In the latter case, we would expect a negative relation between leverage and the use of accounting covenants. The regressions also include a dummy for the availability of U.S. filings, since borrowers with public debt or equity traded in the U.S. might be subject to different financial reporting incentives and face different agency costs.21 To control for debt-level determinants of covenant usage, we include debt size (borrowing amount), maturity (number of months to maturity), yield spread (offering yield to maturity over benchmark risk-free rate)22, an indicator for secured debt, an indicator for the availability of credit ratings, and an indicator for investment grade.23 Since debt issued by the same firm may have different contractual features, we conduct our regression analysis at the debt level, but cluster standard errors by both firm and calendar year of issuance to control for potential correlations across observations within the same firm and year.24

20

For example, Yi (2005) shows that the number of covenants in a loan contract decreases as the intensity of the lending relationship increases. Beatty, Liao, and Weber (2012) find that public bondholders may choose to delegate monitoring of borrowers to existing senior creditors. 21 For example, Ball, Hail, and Vasvari (2013) find that public bonds issued by foreign firms cross-listed in the U.S. have lower interest rates. In untabulated robustness analysis, we also include a dummy variable for the availability of London Stock Exchange filings, and our conclusions are unchanged. 22 For public bonds, the proxy for the benchmark risk-free rate is the three-month LIBOR (interbank) rate at the country where the issuing firm is domiciled, obtained from Datastream. If the LIBOR rate for a country or year is not available, we use the local Treasury bill or government bond rate obtained from IMF. For private loans, consistent with prior literature, we directly use the variable all-in-drawn as a proxy for yield spread. Our results are not sensitive to the choice of the benchmark risk-free rate. 23 We use the average credit rating of the debt issue provided by three rating agencies, Standard & Poor, Moodys, and Fitch. If a rating is not available, we use the average rating for the issuer within one year of the issuance date. Credit ratings of BBB or above for Standard & Poor and Fitch and Baa or above for Moodys are identified as investment grade. As some of these debt characteristics are potentially simultaneously determined with covenant usage, in the robustness section, we evaluate the sensitivity of the results by using IV regressions to address the endogeneity of other debt features. 24 We get very similar and sometimes larger t-statistics if we cluster standard errors only at the firm level, as is common in studies of IFRS adoption effects in capital markets (e.g. Daske, Hail, Leuz, and Verdi, 2008;

25

Country-level controls include legal origin (Civil Law), creditor rights index (Cred Rghts), and the importance of a countrys private debt market (PrivDebt Mkt). These variables are motivated by prior literature and are used as proxies for the level of legal protection that lenders enjoy and the development of the debt market in each country. We also include industry (2-digit SIC) fixed effects to control for industry-specific factors that affect accounting covenant use. All non-ratio accounting variables are converted from local currencies to US dollars using the exchange rate at the fiscal year end. For debt denominated in currencies other than US dollars, the borrowing amount is converted into US dollars using the exchange rate at the issue date. All continuous variables are Winsorized at their 1 and 99 percentage levels. 4.1.1 Sample statistics Table 1 reports by country the sample frequency of debt issues with accounting covenants (the mean of D_ACov) and the intensity of use, defined as the average number of accounting covenants (the mean of Num_ACov). There is large variation in use across countries. Among IFRS-adoption countries, more than 70% of debt issued by firms in South Africa, Philippines, and Greece contains accounting covenants, while no debt issued in Austria, Portugal, or Switzerland contains any accounting covenants. Among non-IFRSadoption countries, more than 98% of debt issued by firms in Taiwan contains accounting covenants, with the average debt contract containing three, while only less than 3% of debt issued by Japanese companies includes any accounting covenants. Table 1 also reports country indexes of legal protection and debt market development. Table 2 and Figure 2 report accounting covenant use by calendar year of debt issuance. Panels A and B plot the frequency and average number of accounting covenants,
Landsman, Maydew, and Thornock, 2012). In following analyses, we report t-statistics with both firm and year clustering, except when specified in Tables 7 and 10.

26

respectively. In Figure 2, the dotted line represents IFRS countries and the solid line represents non-IFRS countries. The vertical lines indicate the time of IFRS adoption, December 2005, and the start of recent financial crisis, July 2007. Prior to 2006, accounting covenant use in IFRS countries and non-IFRS countries appears comparable. Figure 2 indicates the use frequency is volatile during that period, which we attribute to tiny sample sizes (Table 2 shows that neither the treatment nor the control sample exceeds 70 issues per year prior to 2003). Subsequently, the usage rates diverge. For both the frequency and intensity of accounting-based covenant use in debt issuances, we observe a significant decline in IFRS-adoption countries in 2006, a further decline in 2007, and a relatively flat trend after 2007. This evidence is consistent with the hypothesis that debt issued by firms using IFRS contains fewer accounting covenants than debt issued by firms using domestic GAAP.25 From Table 2 Panel A, we note that the drop in accounting covenants for debt issued in IFRS mandating countries occurs for both income statement covenants (D_ACov_IS and Num_ACov_IS) and balance sheet covenants (D_ACov_BS and Num_ACov_BS). The frequency (intensity) declines from 28.4% (0.466) in 2005 to 10.5% (0.200) in 2006 for income statement covenants and from 27.3% (0.352) to 7.6% (0.086) for balance sheet covenants. In contrast to IFRS countries, Table 2, Panel B shows no clear trend in any measure of accounting covenant use after 2005 for firms in non-IFRS countries.26 Table 3, Panels A and B report summary statistics of the regression variables for both treatment and control samples aggregated over all years in the pre- and post-adoption
The correlation of average D_ACov (Num_ACov) between IFRS countries and non-IFRS countries in the figure is 0.003 (0.44) from 1996 to 2005 and -0.50 (-0.56) from 2006 to 2010. 26 We replicate the analysis separately for U.S. firms. Consistent with Demerjian (2011) and Christensen and Nikolaev (2012), we find a decline in balance sheet covenant use between 1996 and 2007, followed by a partial reversal of this trend in the 2007-2010 period. Further, as in the above studies, income statement covenant use was relatively constant over the 1996-2010 period for private loans. However, when we extend the analysis to public bonds, we find a decline in income statement covenant use after the onset of the financial crisis in 2007.
25

27

periods, respectively. In IFRS-adopting countries, there are accounting covenants in 46.5% of debt issued in the pre-adoption period, but only 12.1% in the post-adoption period. The difference is statistically significant. The average number of accounting covenants (Num_ACov) declines from 0.899 to 0.194 around IFRS adoption. This decline of over 70% in covenant intensity is economically and statistically significant. In comparison, a decline is not observed for debt issued in non-IFRS countries. In these countries, average D_ACov in the pre- and post-adoption periods is almost unchanged at 44.2% versus 41.5%, and average Num_ACov is slightly higher in the post-adoption period (1.124 versus 1.021). These statistics indicate that the decline around IFRS adoption is not part of a global trend. The last columns of Table 3 Panel A report mean difference-in-difference statistics, comparing the change in covenant usage around 2005 between IFRS and non-IFRS countries. The mean difference-in-difference values for D_ACov and for Num_ACov are 0.317 (t-stat = -8.71) and -0.807 (t-stat = -8.81). These univariate results provide preliminary evidence that IFRS adoption leads to a decline in both the frequency and intensity of usage of accounting covenants in debt contracts. 4.1.2 Regression models Table 4 reports multivariate regression results for Equations (1) and (2). Consistent with the prediction that accounting covenant use declines after mandatory IFRS adoption, the coefficients on PostIFRS are negative and significant in all model specifications in Panel A, irrespective of controls for firm, industry, debt, and country specific determinants of accounting covenant use. Columns (1) and (2) present results without debt-level controls, some of which could be endogenous to covenant use. However, comparing the results in column (2) with those when controls are included in column (3) shows that the coefficient on PostIFRS declines slightly but is not very sensitive to the inclusion or exclusion of debt28

level determinants. The coefficients on PostIFRS also are economically significant. For example, in column (3) the untabulated marginal effect of PostIFRS is -0.267, indicating that debt issued by firms in IFRS countries is estimated as 26.7% less likely to contain any accounting covenants in the post-adoption period relative to that issued by firms in non-IFRS countries. We address endogeneity further in the robustness section. The coefficients on the firm and debt control variables generally are consistent with prior literature. The negative coefficient on firm size and positive coefficient on market-tobook ratio are consistent with small and high growth firms facing higher agency costs of debt and therefore using more accounting covenants. The negative coefficients on leverage suggest that newly issued debt is less likely to include accounting covenants when the borrower has more debt outstanding, consistent with existing lending relationships and monitoring by existing lenders reducing the need for covenants. Among debt-level control variables, the coefficients on the secured debt indicator and yield spread are significantly positive, and those on the investment grade indicator and maturity are significantly negative. While these are consistent with higher yield spreads/credit ratings reflecting greater/lower agency cots of debt and the demand for monitoring being lower/higher for shorter maturity debt/secured debt, we are careful not to draw strong inferences on these coefficients due to potential endogenous effects. Finally, with regards to the country-level variables, we find negative coefficients on PrivDebt Mkt and positive coefficients on Civil Law, indicating that debt issued by firms located in countries with more developed debt markets and stronger legal protection contain fewer accounting covenants. A pseudo R2 of 7.0% in column (1) and an adjusted R2 of 8.5% in column (4) suggest that indicators for IFRS adoption alone explain a significant amount of variation in the use of accounting covenants. To address the concern that the results might be driven by different sample 29

composition in the pre- and post-adoption periods, we repeat the above analysis by using a constant sample, in which a firm is kept in the sample only if it issues debt in both the preand post-adoption periods. This reduces the sample size to 1,383 observations. Nevertheless, the results in Table 4 Panel B show that the main conclusions hold unchanged. The coefficients on PostIFRS are negative and significant in all model specifications and are comparable to those reported in Panel A, suggesting that differences in the types of firms raising debt between the pre- and post-IFRS periods are not sufficient to explain our results. Table 4 Panel C reports that both income statement and balance sheet covenants exhibit significant decreases after mandatory IFRS adoption.27 The coefficient on PostIFRS is -1.241 (t-stat = -7.65) for income-statement covenants and -0.621 (t-stat = -4.29) for balance sheet covenants in the Probit regressions. The untabulated marginal effects of PostIFRS estimate that debt issued by firms in IFRS countries is 15.7% less likely to contain any income statement covenants and 15.6% less likely to contain any balance sheet covenants in the post-adoption period, relative to debt issued by firms in non-IFRS countries. The coefficients on the control variables are also qualitatively similar to those reported in Panel A. The decline in covenant use after mandatory IFRS adoption is observed in both income statement and balance sheet variables, consistent with our predictions. Defining accounting covenants to exclude those using cash flow numbers does not alter the conclusions.28 Only 17 observations, or 0.6% of the sample, are influenced by this redefinition. Consequently, the results reported in columns titled Ex. Cash Flow in Panel C are very similar to those reported in Panel A.

27

In this panel and all subsequent tables, we report only regressions with all controls including debt-level variables. The conclusions are unaffected if debt-level control variables are excluded. 28 Cash flow covenants are those using cash interest coverage and debt-to-cash-flow ratios. Although the debt numbers could be affected by IFRS and more specifically by fair value accounting requirements, we excluded these ratios from this test to be conservative.

30

4.2 Effect of the difference between IFRS and prior domestic standards If the observed covenant changes are caused by IFRS adoption, they should increase with the degree to which IFRS alters a countrys accounting standards. To test this implication, we create two indexes of the distance between prior domestic GAAP and IFRS. The first index is constructed from the item scores obtained from Bae, Tan, and Welker (2008, Table 1) who list 21 key accounting variables based on the Nobes (2001) GAAP 2001 Survey, and assign a score of 1 for each item that does not conform to International Accountings Standards (IAS), the predecessor of IFRS.29 The first index is the sum of the scores on those items that directly affect financial statement numbers, excluding items that relate only to non-numerical disclosure requirements.30 This index is labelled Bae Acct. The second index is a self-constructed measure capturing the difference between local GAAP and IFRS in terms of fair value accounting in particular. We construct this index by following a similar approach used in Bae, Tan, and Welker (2008). Using Nobes (2001) survey, we identify the differences between local GAAP and the following seven IFRS applications of fair value accounting: IAS 16 (Property, Plant and Equipment), IAS 22 (Business Combinations), IAS 36 (Impairment of Assets), IAS 37 (Provisions, Contingent Liabilities and Contingent Assets), IAS 38 (Intangible Assets), IAS 39 (Financial Instruments), and IAS 40 (Investment Property). For each accounting item, countries that do

29

Nobes (2001) survey is based on accounting standards that were effective on Dec. 31, 2001 and so ignores differences between IAS and national accounting rules emerging from subsequent revisions to standards. Also, the survey ignores differences that might arise from IAS permitting alternative policies, but national rules allowing only one of those alternatives or providing more detailed or more restrictive standards. 30 Items excluded from Bae, Tan, and Welker (2008) are Item 1 (IAS No. 1.7: Do not require a primary statement of changes in equity), Item 3 (IAS No. 14: Require no or very limited segment reporting), Item 7 (IAS No. 2.36: Do not require disclosure of FIFO inventory cost when LIFO is used), Item 9 (IAS No. 24: Have no or very limited disclosure requirements for related-party transactions), Item 11 (IAS No. 32.77: Do not require the disclosure of the fair value of financial assets and liabilities), Item 12 (IAS No. 35: Do not have rules outlining the treatment of discontinued operations), and Item 19 (IAS No. 7: Do not require a statement of cash flow). The above items are listed in Nobes (2001) in the section titled There are no specific rules requiring disclosures of.

31

not conform to IAS receive a score of 1, and all other countries receive a score of 0.31 The index is calculated as the aggregate score of the seven items. This index is labelled FV. Higher index values indicate greater differences between prior domestic GAAP and IFRS.32 Table 1 reports the values of the indexes for countries in the treatment sample. The sample medians for the Bae Acct and FV indexes are 7 and 4, respectively. Values cannot be computed for non-IFRS countries, so analyses based on these indexes are restricted to firms in IFRS countries. The association between post-IFRS change in accounting covenant use and difference between local GAAP and IFRS is estimated from the following model: Pr(D_ACov=1) = 1 Post+ 2 Index+ 3 PostIndex+Control Variables Log(1+Num_ACov) = 1 Post+ 2 IFRS+ 3 PostIndex +Control Variables (4) (3)

Index is defined as Bae Acct or FV and other variables are defined as before. Because the indexes are count variables, we normalize their values between 0 and 1 to facilitate interpretation of the regression coefficients. Regression results are reported in Table 5. The coefficients on PostIndex are negative and significant in all model specifications, suggesting that the decrease in accounting covenant use in the post-adoption period is increasing in the difference between prior domestic GAAP and IFRS. For the Probit regressions, the untabulated marginal effect of PostIndex is -0.329 (-0.266) when Bae Acct (FV) is used as the index, indicating that

Countries in our treatment sample that receive 1 for IAS 16 include Greece, Italy, Netherlands, Philippines, Portugal, Spain, and Sweden; countries that receive 1 for IAS 22 include Austria, Belgium, Denmark, Germany, Philippines, and Spain; countries that receive 1 for IAS 36 include all countries in our treatment sample except Australia, Hong Kong, Ireland, Netherlands, South Africa, and UK; countries that receive 1 for IAS 37 include all countries in our treatment sample except Hong Kong, Ireland, South Africa, and UK; countries that receive 1 for IAS 38 include Australia, Belgium, Denmark, France, Germany, Norway, Portugal, and Spain; all countries in our treatment sample receive 1 for IAS 39; countries that receive 1 for IAS 40 include Australia, France, Greece, Hong Kong, Ireland, Netherlands, South Africa, Sweden, and Switzerland. 32 The indexes do not take into account changes in domestic accounting standards after 2001. After the vote in 2002 by the European Union to adopt IFRS, many IFRS-adoption countries in our sample changed their domestic accounting standards to ease the transition to IFRS.

31

32

debt issued by firms in countries with highest Bae Acct (FV) index is 32.9% (26.6%) less likely to contain any accounting covenants in the post-adoption period relative to that issued by firms in countries with the lowest index. The coefficients on the control variables are qualitatively similar to those reported in Table 4, except that the Civil Law variable is statistically insignificant in the current table.

5. Additional Analyses
5.1 Loans versus bonds Public bond contracts and syndicated bank loans differ in borrowing incentives, monitoring, and contractual features generally. Syndicated bank lenders can monitor borrowers and renegotiate loans at lower cost than public bondholders, due to concentrated loan ownership, financial expertise, and access to private information. Thus, bank loans typically have a larger number of tightly set accounting covenants that are more frequently violated and renegotiated (Nini, Smith, and Sufi, 2012). Public bondholders typically do not have access to private information, and their dispersed ownership makes renegotiation more costly. Thus, bond contracts typically have fewer accounting covenants, which when used are often more loosely set. In addition, public bonds often are subordinated and contain callable and/or convertible features, while syndicated bank loans often involve revolving credit or include performance pricing. Because of their greater reliance on accounting covenants, we expect IFRS adoption to have a greater impact on loans than bonds. Separate regression results for public bond and private loan samples are reported in Table 6, using both Equations (1) and (3). We also test the difference in coefficients between

33

the two types of debt.33 In the difference-in-difference regressions, the coefficient on PostIFRS is negative and significant for loans but negative and insignificant for bonds. The difference between the loan and bond coefficients also is negative and significant. The decline in accounting covenant use following mandatory IFRS adoption thus appears more pronounced for loans than for bonds, consistent with loans being more reliant on accounting covenants and more affected by the accounting change. As expected, the coefficients on the control variables also differ between the loan and bond samples. In the cross-sectional regressions, reported in the columns titled Bae Acct and FV in Table 6, the coefficients on PostIndex are significantly negative for both indexes of the difference between local GAAP and IFRS in the loan regression and significantly negative in the bond regression using the Bae Acct index. The coefficient magnitudes are considerably larger in the loan regressions and the differences are significant.34 5.2 Country and year fixed effects One concern is that our specifications might omit country characteristics that are correlated with both IFRS adoption and accounting-based covenants. The country-level control variables ameliorate this concern, but nevertheless we examine the sensitivity of the results to including country fixed effects that absorb all time-invariant differences across countries. We also include year fixed effects to control for potential time-specific effects in debt contracting, including trends. Further, we check the robustness of the results to computing standard errors based on clustering observations at both the country and year levels. This is a conservative approach as clustering by country and year lowers degrees of freedom and power.
33

We do not include loan specific controls, such as indicators for revolving credit, term loan, performance pricing, or bond specific controls such as indicators for subordinated bond, callable bond, and convertible bond. In untabulated results, we get qualitatively similar results when including them. 34 In the bond regressions, the dummy variable D_Secured is dropped due to multicollinearity.

34

The results, reported in Table 7, show that our main results are unaffected by these changes.35 Specifically, the coefficients on PostIFRS and PostIndex continue to be negative and significant. 5.3 Other covenants Demerjian (2012) suggests that covenants are a mechanism that allows lenders and borrowers to contract even when lenders do not have certain information about borrowers prior to contracting. The covenants force borrowers to renegotiate with lenders at a future date when new information is received. This argument predicts that the demand for covenants increases in the lenders ex-ante uncertainty about the borrower. If IFRS adoption improved financial transparency and thereby lowered the ex-ante uncertainty about borrowers, this argument could explain the observed decline in accounting covenants after IFRS adoption. It thus is an alternative to our hypothesis that IFRS adoption makes accounting numbers less relevant for debt contracting. A differentiating test is as follows. Our hypothesis predicts a substitution away from accounting-based covenants to non-accounting covenants, implying an increase in nonaccounting covenant use following IFRS adoption. The hypothesis that IFRS improved transparency predicts a reduced demand for all covenants, non-accounting included (if anything, it predicts a substitution toward IFRS-based accounting covenants). To test this prediction, we identify four common types of non-accounting covenants based on their functionality: investment restrictions, asset sale restrictions, equity issue restrictions, and debt issue restrictions. Although dividend restrictions also are frequently observed in debt covenants, we do not consider these as a non-accounting covenant, as they typically are based on the amount of accounting earnings or retained earnings (Healy and Palepu, 1990).
35

IFRS and Post dummies are not included by themselves in these regressions as their effects are subsumed by country fixed effects and year fixed effects, respectively.

35

Nonetheless, for completeness we also report the effect of IFRS adoption on dividend restrictions. The covenant classifications are based on Bratton (2006). Table 8 reports results. In the first five columns of Table 8, Panel A, the dependent variable is defined as one if the debt contract has at least one covenant of the specified type, and zero otherwise.36 The results indicate that investment restrictions and equity issue restrictions increase after IFRS adoption, while dividend and debt issue restrictions remain unchanged and asset sale restrictions decrease.37 An Ordered Logit regression where the dependent variable is Four_NACov, the sum of the four dummies defined above (dividend restrictions excluded) confirms these results. These results are not consistent with the alternative hypothesis that improved financial transparency from IFRS adoption mitigates the need for debt covenants. We also examine covenants that are specific to bonds or loans and find that private loan contracts are more likely to use prepayment restrictions while public bond contracts are more likely to use merger restrictions after IFRS adoption. The coefficients on PostIFRS are insignificant when dummies for cross-default covenants on bonds or prior claim restrictions on bonds are the dependent variables. 38 The last two columns of Table 8, Panel A, present results from OLS regressions of the ratio of accounting covenants to non-accounting covenants, where non-accounting covenants are either Four_NACov or computed as the total number of covenants minus the number of accounting covenants. If both covenant types declined proportionally after IFRS adoption, these ratios would not differ between the pre- and post-IFRS adoption periods.
36

The sample size is smaller for investment restriction, equity issue restriction, debt issue restriction, and fourtype Ordered Logit regressions due to missing information on these covenant types for some of the data sources. 37 One reason for the decline in asset sale restrictions could be that these restrictions often rely on accounting numbers (viz., net worth) to define whether an asset sale is substantial or not. These covenants tend to permit sales of assets not exceeding a set percentage of net worth or total assets. 38 The sample size is smaller for cross-default covenants for the bond sample, as some of the data sources do not have information on this covenant type.

36

Irrespective of the proxy for non-accounting covenants, the results document a negative coefficient on POSTIFRS, implying that after IFRS adoption, fewer accounting covenants relative to non-accounting covenants were being employed in debt contracts. Table 8, Panel B examines the effect as a function of countries prior domestic accounting standards. We repeat the analysis in Table 5 using either Four_NACov or the ratio of accounting to non-accounting covenants as dependent variables. The results from regressions of Four_NACov indicate that, for both the Bae_Acct and FV indexes, the coefficient on PostIndex is positive. It is statistically significant when the index is Bae_Acct. These results are consistent with the number of non-accounting covenants increasing with the difference between IFRS and prior domestic GAAP. Moreover,

consistent with accounting covenants declining relative to non-accounting covenants, the coefficient on PostIndex is negative in all regressions of the ratio of accounting covenants to non-accounting covenants and is significantly negative in three of the four regressions. Overall, these results support the earlier findings that indicate a shift from accounting covenants to non-accounting covenants after IFRS adoption. Further, they do not support the argument that improved transparency under IFRS lowers the demand for both nonaccounting and accounting-based covenants in debt contracts. 5.4 Matched sample approach An additional concern is that differences in characteristics of sample firms issuing debt between the pre- and post-adoption periods could drive our results. Although the constant sample results reported in Table 4, Panel B ameliorate this concern, we repeat the analyses using an alternative matching scheme, matching firms in the pre-adoption period with those in the post-adoption period.

37

The results are reported in Table 9. In columns Matched by Size&MTB and Matched by Size&Lev each firm-year in the pre-adoption period is matched with one in the post-adoption period by size and market-to-book (leverage) decile. If multiple matches occur within the same size and market-to-book decile, the closest size and market-to-book (leverage) observation is used. Only debt with a firm-year match is retained. The above matching procedure is conducted separately for the treatment and control samples. The results, reported in Table 9, remain unchanged. 5.5 Joint determination of debt contractual features Agency theory suggests that debt contractual characteristics are simultaneously determined (Smith and Warner, 1979). While the main conclusions are unaffected by controlling for debt attributes (Table 4), we address potential simultaneity by estimating five sets of Instrumental Variable (IV) regressions. In each set, one of five debt features is treated as the endogenous variable, namely: dummies for secured debt (D_Secured) and investment grade debt (InvestGrade), yield spread (Yield Spread), issuance size (Log(Debt Size)), and maturity (Log(Maturity)). For each endogenous variable, the instruments used are the sample mean of all debt issued by firms in the same 2-digit SIC industry and year, and the sample mean of all debt issued by firms in the same country within a six-month period prior to the issue date. Using industry and country averages as instruments is consistent with prior literature (e.g., Lev and Sougiannis, 1996; Hanlon, Rajagopal, and Shevlin, 2003) and with the argument that the market average reflects the demand for debt (Bharath, Dahiya, Saunders, and Srinivasan, 2011; Ivashina and Sun, 2011; Costello and Wittenberg-Moerman, 2011). We construct these instruments separately for the loan and bond samples and require at least three observations to calculate the sample mean. We use the inclusion criterion proposed in Larcker and Rusticus (2010) to validate the instruments. 38

Table 10 reports the IV regression results. We report the results of both first stage regression on endogenous variables and second stage IV regression results on D_ACov and Num_ACov.39 To test the relevance of instrumental variables, we report a partial R2 that measures the explanatory power of the instrumental variables on the endogenous variable. The partial R2s of the instruments range from 1.4% to 33.5%, and all instruments have significant coefficients in the first stage regressions. We also report the KleibergenPaap Wald rk F-statistic as a test for weak identification in the context of clustered standard errors. All F-statistics exceed the critical value of 8.92, indicating the instruments are not weak. The coefficient on PostIFRS continues to be negative and significant in all the second-stage regressions on D_ACov and negative and significant in most second-stage regressions on Log(1+Num_ACov). 5.6 Announcement versus implementation of IFRS adoption We next examine whether it is the announcement of IFRS adoption in 2002 or the actual IFRS adoption in 2005 that best explains the change in accounting covenant use. We implement this test by adding a dummy variable PostAnnoun for the pre- and post-2002 periods and interacting it with the IFRS dummy in Equations (1) and (2), where the postannouncement period is defined as fiscal years ending in or after December 2002. We exclude countries that announced IFRS adoption in years other than 2002 (see Table 1). The regression results, as reported in columns headed Announ. Effect in Table 11, indicate positive but insignificant coefficients on PostAnnounIFRS, whereas the coefficient on PostIFRS continues to be significantly negative. These results are consistent with the actual adoption of IFRS explaining the reduced use of accounting numbers in covenants.

39

We continue to cluster standard errors by both firm and year except for the IV regressions on binary variable D_ACov, where the standard errors are only clustered by firm as the IV Probit model does not allow for twoway clustering.

39

5.7 Shorter event windows To examine the sensitivity of the results to shorter event windows around IFRS adoption, we repeat the analysis in Table 4 after limiting the sample to one year, two years, or three years around 2005, the IFRS adoption year. The regression results reported in Table 11 suggest that the coefficients on PostIFRS remain negative and significant at conventional levels across different event windows. The significant decline in accounting covenant use observed in shorter event windows around 2005 and the lack of a significant decline immediately after IFRS announcement in 2002, further ameliorate concerns that the documented decline in covenant use is due to contaminated events. To examine the trend of using accounting covenants in the post-adoption period, we create yearly dummies to replace the Post indicator in Equations (1) and (2). Untabulated results suggest that accounting covenant use started to decline immediately after the 2005 adoption year, declined further in 2006, and remained relatively stable in following years, consistent with the trend observed in Figure 2. 5.8 Enforcement effect We exploit country differences in years of introducing IFRS and improved regulatory enforcement to investigate their relative roles. Mere adoption of standards appears not to improve financial transparency unless combined with effective enforcement (e.g., Ball, 2001; Ball, Robin, and Wu, 2003). Consistent with this argument, Daske, Hail, Leuz, and Verdi (2008) find that capital market benefits of IFRS adoption are observed only in countries where firms have incentives to be transparent and where legal enforcement is strong. In addition, Byard, Li, and Yu (2011) find that IFRS adoption only improves analysts information environment in countries with both strong enforcement and domestic accounting standards that differ significantly from IFRS. Lax enforcement of IFRS could reduce 40

accounting covenants in debt contracting because IFRS standards are more principle-based and provide managers more flexibility in reporting (Barth, Landsman, and Lang, 2008). We investigate EU member countries implementation of the Transparency Directive (TPD). The TPD, which was passed by the EU legislature in 2004, requires listed firms to periodically disclose certain information. Member countries implemented this directive at different points in time, which allows us to evaluate the effect of enforcement changes on debt contracting and contrast it with the effects of IFRS adoption in 2005. Christensen, Hail, and Leuz (2011) observe that the TPD introduced significant regulatory improvements and show that, along with the Market Abuse Directive, it led to significant improvements in market liquidity in the implementing countries. The date when the TPD was enforced for each EU country is reported in Table 1. For most EU countries, the TPD was enforced in 2007 and 2008 (i.e. after mandatory IFRS adoption). We create a dummy variable PostTPD equal to one for fiscal years ending after TPD enforcement and interact it with the Bae Acct and FV index measures. The results in Table 12 Panel A suggest that the TPD did not affect accounting covenant use. Following prior literature, we use the rule of law index (Rule of Law) and regulatory quality index (Regulatory Quality) for 2005 obtained from Kaufmann, Kraay, and Mastruzzi (2009), as alternative measures for the strength of a countrys legal enforcement (e.g., Byard, Li, and Yu, 2011; Landsman, Maydew, and Thornock, 2012; Christensen, Hail, and Leuz, 2011). These measures are reported in Table 1 for each of the treatment countries. In the regression analysis, we interact the Post dummy with these two indexes. The results in Table 12, Panel B further suggest that the observed decline in accounting covenant use does not vary across regimes as a function of the strength of legal enforcement.

41

The results in this section are not consistent with the observed decline in accounting covenant use being due to improved financial transparency associated with better enforcement. They are more consistent with IFRS effects. 5.9 Other robustness analyses IFRS adoption could influence the firm-level controls used in our analysis, for example by changing how they are measured. To test this, we replace the post-adoption values of the accounting-based control variables (Leverage, Size, MTB, ROA, and Tangibility) with their values in the year prior to IFRS adoption. The results reported earlier are qualitatively unaffected by this change. Debt issued during the financial crisis period might differ in its use of accounting and other covenants. To test this, we exclude debt issued during that period, using September 2008 and July 2007 as alternative cut-off dates and find robust results. 5.10 Hand-collected data The analyses so far are based on machine-readable data compiled from various databases. A potential concern is that our results could be due to an unobservable change in the way the data providers cover debt issues or classify covenants. This seems unlikely, since (for it to show up in our difference-in-difference tests) the change would need to occur both at the time of IFRS adoption and in IFRS adopting countries but not in non-adopting countries. It would need to be independent of the firm, industry, and debt issue characteristics for which we control. To investigate this possibility we hand-collected a sample of original bond prospectuses and read the details of their covenant sections.40 Of the 2,242 bond contracts in our final sample (Table 6), we are able to download the prospectus in English from Perfect
40

Ideally, we would hand-collect covenant data for syndicated loans, but due to their private nature we are not able to locate a meaningful-sized sample.

42

Information or Form 424B in Edgar for 758 observations, with 616 from IFRS countries and 142 from non-IFRS countries.41 We manually code the information on: collateral, credit ratings, accounting standards used by the issuer, different types of covenants, whether these covenants use accounting items, and the definitions of accounting items used in covenants. For the hand-collected data, we broaden the definition of an accounting covenant to any that contains at least one income statement or balance sheet item in its description. For these 758 observations, the machine-readable data provide significantly lower accounting covenant use than the hand-collected data. The mean of Num_ACov (D_ACov) is 0.212 (0.131) for the machine-readable data and 1.281 (0.375) for the hand-collected data, with the differences being statistically significant. The Pearson correlation for Num_ACov (D_ACov) between the two data sets is 0.63 (0.37). In Table 13, we repeat the Probit regression analysis for Equations (1) and (3) by replacing machine-readable data with hand-collected data wherever appropriate. The results are similar to those reported above. The coefficients on PostIFRS in the difference-indifference analysis are smaller in magnitude than those reported in Panel C of Table 4, but remain negative and significant. The coefficients on PostIndex, which estimate the effect of the difference between prior domestic standards and IFRS, are slightly smaller in magnitude than those reported in Table 5, and also remain negative and significant. We get qualitatively similar results (unreported) by repeating the analysis for Equations (2) and (4).

6. Conclusions
Despite substantial research on equity market effects of IFRS, there is scant evidence on IFRS in contracting contexts. Wu and Zhang (2009) and Ozkan, Singer, and You (2012)
41

Firms are required by SEC to file Form 424B if they issue public bonds in the U.S. These firms may still use their home countrys accounting standards instead of U.S. GAAP.

43

examine the effect of IFRS adoption on using accounting information in firms internal performance evaluation. Kim, Tsui, and Yi (2011) find that voluntary IFRS adoption is associated with banks charging lower interest rates, using less restrictive covenants, and making larger loans with longer maturities, but voluntary IFRS adoption most likely is confounded by the characteristics of voluntary adopters, such as size, international diversification, and corporate governance. This concern is somewhat mitigated in the context of mandatory IFRS adoption of IFRS, which provides a more natural experiment. Relative to the prior domestic standards they replaced, IFRS give greater priority to providing information about the current fair values of assets and liabilities. For a variety of reasons, we argue that this feature compromises the external contracting usefulness of financial statements under IFRS. We also conjecture that several other properties of IFRS add uncertainty in accounting numbers that is detrimental to debt contracting. WE predict a consequential decline in use of accounting-based debt covenants Using an international sample of debt contracts issued by firms in countries that mandated IFRS adoption in 2005 and in countries that did not adopt IFRS, we find that accounting covenant use declines after IFRS adoption. Reduced accounting-based covenant use is, at least in part, substituted by greater reliance on non-accounting debt covenants. The decline in accounting covenant use increases in the aggregate difference between prior domestic GAAP and IFRS. Results are robust with respect to a variety of tests. The contrasting results for debt and equity suggest that capital market users are not homogeneous, and thereby challenge the rationale for general purpose accounting standards. From a debt contracting perspective, a consistent accounting measurement model for all assets and liabilities is not clearly optimal. The results also highlight the importance from a debt contracting perspective of accounting recognition, as distinct from disclosure. 44

References
Armstrong, C. S., M. E. Barth, A. D. Jagolinzer, and E. J. Riedl. 2010. Market Reaction to the Adoption of IFRS in Europe. The Accounting Review 85 (1): 3161. Bae, K.-H., H. Tan, and M. Welker. 2008. International GAAP differences: The impact on foreign analysts. The Accounting Review 83 (3): 593628. Ball, R. 2001. Infrastructure requirements for an economically efficient system of public financial reporting and disclosure. Brookings-Wharton papers on financial services 2001 (1): 127169. Ball, R., A. Robin, and J. S. Wu. 2003. Incentives versus standards: properties of accounting income in four East Asian countries. Journal of Accounting and Economics 36 (13): 235270. Ball, R. T., L. Hail, and F. P. Vasvari. 2013. Equity Cross-Listings in the U.S. and the Price of Debt. ECGI Finance Working Paper. Barth, M. E. 2013. Measurement in Financial Reporting: The Need for Concepts. Stanford Univeersity Working Paper. Barth, M. E., W. R. Landsman, and M. H. Lang. 2008. International Accounting Standards and Accounting Quality. Journal of Accounting Research 46 (3): 467498. Becker, B., and P. Strmberg. 2012. Fiduciary Duties and Equity-debtholder Conflicts. Review of Financial Studies 25 (6): 19311969. Bharath, S. T., S. Dahiya, A. Saunders, and A. Srinivasan. 2011. Lending Relationships and Loan Contract Terms. Review of Financial Studies 24 (4): 11411203. Byard, D., Y. Li, and Y. Yu. 2011. The Effect of Mandatory IFRS Adoption on Financial Analysts Information Environment. Journal of Accounting Research 49 (1): 6996. Chambers, R. J. 1966. Accounting, evaluation, and economic behavior. Englewood Cliffs, N.J.: Prentice-Hall. Christensen, H. B., L. Hail, and C. Leuz. 2013. Mandatory IFRS Reporting and Changes in Enforcement. University of Chicago Working Paper. Christensen, H. B., and V. V. Nikolaev. 2012. Capital Versus Performance Covenants in Debt Contracts. Journal of Accounting Research 50 (1): 75116. . 2013. Does fair value accounting for non-financial assets pass the market test? Review of Accounting Studies 18 (3): 734775. Coase, R. H. 1937. The Nature of the Firm. Economica 4 (16): 386405. . 1960. The Journal of LAW c. Journal of Law and Economics 3: 144. Commons, J. R. 1931. Institutional Economics. The American Economic Review 21 (4): 648657. Costello, A. M., and R. Wittenberg-Moerman. 2011. The Impact of Financial Reporting Quality on Debt Contracting: Evidence from Internal Control Weakness Reports. Journal of Accounting Research 49 (1): 97136. Daske, H., L. Hail, C. Leuz, and R. Verdi. 2008. Mandatory IFRS Reporting around the World: Early Evidence on the Economic Consequences. Journal of Accounting Research 46 (5): 10851142. Debreu, G. 1959. Theory of value: An axiomatic analysis of economic equilibrium. 17. Yale University Press. . 1984. Economic theory in the mathematical mode. The Scandinavian Journal of Economics 86 (4): 393410.

45

DeFond, M., X. Hu, M. Hung, and S. Li. 2011. The impact of mandatory IFRS adoption on foreign mutual fund ownership: The role of comparability. Journal of Accounting and Economics 51 (3): 240258. Deloitte. 2011. CFO insights: Will IFRS trip up your debt covenants? Deloitte Touche Tohmatsu, at: http://filesite.deloittenet.deloitte.com/FileHost/2011-0509/deloitte_us_cfo_ifrsdebt_021611.pdf. Demerjian, P. R. 2011. Accounting standards and debt covenants: Has the balance sheet approach led to a decline in the use of balance sheet covenants? Journal of Accounting and Economics 52 (23): 178202. . 2013. Uncertainty and debt covenants. University of Washington Working Paper. Ernst and Young. 2005. How fair is fair value? IFRS Stakeholder Series, London, Ernst and Young. European Commission, 2008. Evaluation of the Application of IFRS in the 2006 Financial Statements of EU Companies, available at http://ec.europa.eu/internal_market/accounting/docs/studies/2009-report_en.pdf. FASB. 2005. The FASB Report, available at http://www.fasb.org/articles&reports/relevance_and_reliability_tfr_feb_2005.pdf. FASB. 2006. Conceptual framework for financial reporting. Preliminary Views Norwalk, Connecticut: Financial Accounting Standards Board. FASB. 2008. Conceptual framework for financial reporting. Exposure Draft. Norwalk, Connecticut: Financial Accounting Standards Board. FASB. 2010. Statement of Financial Accounting Concepts No. 8: Conceptual framework for financial reporting. Norwalk, Connecticut: Financial Accounting Standards Board. FASB. 2013. International Convergence of Accounting Standards Overview, available at http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156245663, visited 11th June 2013. Hanlon, M., S. Rajgopal, and T. Shevlin. 2003. Are executive stock options associated with future earnings? Journal of Accounting and Economics 36 (13): 343. Healy, P. M., and K. G. Palepu. 1990. Effectiveness of accounting-based dividend covenants. Journal of Accounting and Economics 12 (13): 97123. Holmstrom, B. 1982. Moral Hazard in Teams. The Bell Journal of Economics 13 (2): 324 340. Hlmstrom, B. 1979. Moral Hazard and Observability. The Bell Journal of Economics 10 (1): 7491. IASC Foundation. 2002. Draft Preface to International Financial Reporting Standards. London, United Kingdom: IASC Foundation. Ivashina, V., and Z. Sun. 2011. Institutional stock trading on loan market information. Journal of Financial Economics 100 (2): 284303. Jensen, M. C., and W. H. Meckling. 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics 3 (4): 305360. Kim, J.-B., J. S. L. Tsui, and C. H. Yi. 2011. The voluntary adoption of International Financial Reporting Standards and loan contracting around the world. Review of Accounting Studies 16 (4): 779811. Knight, F. H. 1921. Risk uncertainty and profit. Hougton Mifflin company. KPMG IFRG Limited. 2010. New on the Horizon: Fair value option for financial liabilities, available at http://www.kpmg.com/MT/en/IssuesAndInsights/ArticlesPublications/Documents/New -on-the-Horizon-Fair-value-option-for-financial-liabilities.pdf 46

Kvaal, E., and C. Nobes. 2010. International differences in IFRS policy choice: A research note. Accounting and Business Research 40 (2): 173187. Landsman, W. R., E. L. Maydew, and J. R. Thornock. 2012. The information content of annual earnings announcements and mandatory adoption of IFRS. Journal of Accounting and Economics 53 (12): 3454. Larcker, D. F., and T. O. Rusticus. 2010. On the use of instrumental variables in accounting research. Journal of Accounting and Economics 49 (3): 186205. Leftwich, R. 1983. Accounting Information in Private Markets: Evidence from Private Lending Agreements. The Accounting Review 58 (1): 2342. Lev, B., and T. Sougiannis. 1996. The capitalization, amortization, and value-relevance of R&D. Journal of Accounting and Economics 21 (1): 107138. Li, N. 2010. Negotiated Measurement Rules in Debt Contracts. Journal of Accounting Research 48 (5): 11031144. Lins, K. V., H. Servaes, and A. Tamayo. 2011. Does Fair Value Reporting Affect Risk Management? International Survey Evidence. Financial Management 40 (3): 525551. Nikolaev, V. V. 2010. Debt Covenants and Accounting Conservatism. Journal of Accounting Research 48 (1): 5189. Nini, G., D. C. Smith, and A. Sufi. 2009. Creditor control rights and firm investment policy. Journal of Financial Economics 92 (3): 400420. . 2012. Creditor Control Rights, Corporate Governance, and Firm Value. Review of Financial Studies 25 (6): 17131761. Nobes, C. 2001. GAAP 2001A Survey of National Accounting Rules Benchmarked Against International Accounting Standards. International Forum on Accountancy Development (IFAD). Ozkan, N., Z. Singer, and H. You. 2012. Mandatory IFRS Adoption and the Contractual Usefulness of Accounting Information in Executive Compensation. Journal of Accounting Research 50 (4): 10771107. La Porta, R., F. Lpez de Silanes, A. Shleifer, and R. Vishny. 1998. Law and finance. Journal of Political Economy 106: 11131155. Qian, J., and P. E. Strahan. 2007. How Laws and Institutions Shape Financial Contracts: The Case of Bank Loans. The Journal of Finance 62 (6): 28032834. Ross, S. A. 1973. The Economic Theory of Agency: The Principals Problem. The American Economic Review 63 (2): 134139. Smith Jr., C. W., and J. B. Warner. 1979. On financial contracting: An analysis of bond covenants. Journal of Financial Economics 7 (2): 117161. Watts, R. L. 2003. Conservatism in Accounting Part I: Explanations and Implications. Accounting Horizons 17 (3): 207221. Watts, R. L., and Zimmerman. 1986. Positive accounting theory. Englewood Cliffs, N.J.: Prentice-Hall. Williamson, O. E. 1979. Transaction-Cost Economics: The Governance of Contractual Relations. Journal of Law and Economics 22 (2): 233261. . 1981. The Economics of Organization: The Transaction Cost Approach. American Journal of Sociology 87 (3): 548577. Wu, J. S., and I. X. Zhang. 2009. The Voluntary Adoption of Internationally Recognized Accounting Standards and Firm Internal Performance Evaluation. The Accounting Review 84 (4): 12811309. Yi, S. 2005. Firm Characteristics, Lending Relationship, and Loan Covenant Strictness. Unpublished Dissertation, Michigan State University. 47

Table 1: Sample composition by country

This table reports the number of observations, mean values of measures for accounting covenants, and institutional indexes for each of our sample countries. Panel A reports the statistics for the treatment sample, i.e. debt issued by firms domiciled in countries outside the U.S. that mandated IFRS adoption in 2005. Panel B reports the statistics for the control sample, i.e. debt issued by firms domiciled in countries outside the U.S. that did not have major change in accounting regime during the sample period. D_ACov is a dummy variable indicating that the debt contract contains at least one accounting-based covenant. Num_ACov is the total number of accounting covenants contained in a debt contract. Cred Rghts is an index measuring the strength of a countrys creditor protection and is obtained from Djankov, McLiesh, and Shleifer (2007). PrivDebt Mkt is a dummy variable indicating the importance of a countrys private long-term debt financing market and is obtained from Bushman and Piotroski (2006). Civil Law is a dummy variable indicating that the firm is incorporated in a civil law country and is obtained from La Porta, Lopes-de Silanes, Shleifer, and Vishny (1998). Bae Acct is an index measuring the difference between domestic GAAP and IFRS in terms of accounting items. It is the sum of 14 out of 21 items obtained from Table 1 of Bae, Tan, and Welker (2008). Items 1, 3, 7, 9 11, 12, and 19 are exclude for the calculation of this index as they only influence disclosures but not accounting numbers. The numbers in parentheses indicate the normalized value. FV is a self-constructed index measuring the difference between domestic GAAP and IFRS in terms of fair value accounting. The numbers in parentheses indicate the normalized value. Announ. Date is the date when each country announced the mandatory adoption of IFRS and is obtained from Daske, Hail, Leuz, and Verdi (2008). T. P. Date is the date when Transparency Directive came into force for each EU country and is obtained from Christensen, Hail, and Leuz (2011). Rule of Law and Regulatory Quality are measured at year 2005 and are obtained from Kaufmann, Kraay, and Mastruzzi (2009).

48

Table 1 (contd)
Country N D_ ACov 0.364 0.000 0.032 0.000 0.159 0.333 0.415 0.200 0.217 0.284 0.750 0.613 0.593 0.222 0.306 0.299 0.789 0.000 0.163 0.714 Num_ ACov 0.712 0.000 0.065 0.000 0.304 0.667 0.512 0.400 0.420 0.547 3.250 0.903 1.222 0.347 0.408 0.433 1.895 0.000 0.349 1.500 Cred Rghts 3 3 2 1 3 3 2 1 0 4 1 4 1 2 3 2 1 1 1 3 PrivDebt Mkt 1 1 1 0 1 1 0 1 1 0 0 0 0 1 1 1 0 1 1 0 Civil Law 0 1 1 1 1 1 1 1 1 0 1 0 0 1 1 1 1 1 1 0 Bae Acct Index 3 6 8 7 6 8 9 8 8 1 10 2 1 7 3 6 9 8 7 0 (0.3) (0.6) (0.8) (0.7) (0.6) (0.8) (0.9) (0.8) (0.8) (0.1) (1.0) (0.2) (0.1) (0.7) (0.3) (0.6) (0.9) (0.8) (0.7) (0.0) 4 4 5 4 5 5 6 3 5 1 5 2 2 4 4 4 5 5 5 2 FV Index (0.6) (0.6) (0.8) (0.6) (0.8) (0.8) (1.0) (0.4) (0.8) (0.0) (0.8) (0.2) (0.2) (0.6) (0.6) (0.6) (0.8) (0.8) (0.8) (0.2) Announ. Date 4-Jul-2002 4-Jun-2002 4-Jun-2002 11-Nov-2002 4-Jun-2002 4-Jun-2002 4-Jun-2002 4-Jun-2002 4-Jun-2002 4-Jun-2002 4-Jun-2002 10-Sep-2004 4-Jun-2002 4-Jun-2002 4-Jun-2002 4-Jun-2002 2-Oct-2003 4-Jun-2002 4-Jun-2002 20-May-2002 T. D. Date n.a. Apr-2007 Sep-2008 n.a. Jan-2007 Jun-2007 Dec-2007 Feb-2007 Dec-2007 Jan-2007 Jul-2007 n.a. Jul-2007 Apr-2009 Jan-2009 Jan-2008 n.a. Nov-2007 Jul-2007 n.a. Rule of Law 1.713 1.864 1.237 1.887 1.654 1.950 1.096 1.957 1.402 1.546 0.774 1.601 1.571 0.459 1.747 1.907 -0.366 1.186 1.779 0.133 Regulatory Quality 1.62 1.56 1.29 1.47 1.42 1.71 1.23 1.76 1.10 1.58 0.88 1.84 1.59 0.89 1.70 1.47 -0.05 1.20 1.53 0.48

Panel A: IFRS countries (Treatment sample) Australia Austria Belgium Switzerland Germany Denmark Spain Finland France U. K. Greece Hong Kong Ireland Italy Netherlands Norway Philippines Portugal Sweden South Africa Total Brazil Canada Indonesia India Japan Mexico Thailand Taiwan Total 66 11 31 24 69 9 41 40 276 426 4 31 27 72 49 97 19 13 43 14 1,362 100 191 45 85 647 130 71 406 1,675

0.460 0.482 0.733 0.412 0.028 0.523 0.211 0.983

0.810 0.953 1.156 0.894 0.051 0.877 0.282 3.155

1 1 2.07 2 2.03 0 2.03 2

Panel B: Non-IFRS countries (Control sample) 1 1 0 0 0 1 0 0 1 1 0 1 1 0 0 1

49

Table 2: Sample composition by year

This table reports the number of observations and the mean values of measures for accounting covenants by the calendar year of debt issuance date. Panel A reports the statistics for the treatment sample, i.e. debt issued by firms domiciled in countries that mandated IFRS adoption in 2005. Panel B reports the statistics for the control sample, i.e. debt issued by firms domiciled in countries outside the U.S. that did not have major change in accounting regime during the sample period. D_ACov is a dummy variable indicating that the debt contract contains at least one accounting-based covenant. Num_ACov is the total number of accounting covenants contained in a debt contract. D_ACov_IS is a dummy variable indicating that the debt contract contains at least one accounting covenant based on income statement items, such as interest coverage ratio, fixed charge ratio, debt service coverage, etc. Num_ACov_IS is the total number of accounting covenants based on income statement items. D_ACov_BS is a dummy variable indicating that the debt contract contains at least one accounting covenant solely based on balance sheet items, such as current ratio, quick ratio, leverage ratio, net worth, etc. Num_ACov_BS is the total number of accounting covenants solely based on balance sheet items. All continuous variables are winsorized at the 1st and 99th percentiles.

50

Table 2 (contd)
Panel A: IFRS countries(Treatment sample) Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 N 22 29 53 69 69 66 68 75 61 88 105 150 119 264 124 D_ACov 0.318 0.310 0.415 0.652 0.420 0.288 0.441 0.520 0.639 0.466 0.162 0.107 0.092 0.129 0.137 Num_ ACov 0.773 0.621 0.698 1.261 0.942 0.606 0.912 1.173 0.902 0.818 0.286 0.160 0.176 0.189 0.234 D_ACov _IS 0.273 0.138 0.151 0.522 0.261 0.212 0.265 0.413 0.361 0.284 0.105 0.027 0.059 0.023 0.032 Num_ACov _IS 0.409 0.207 0.208 0.826 0.435 0.439 0.515 0.800 0.508 0.466 0.200 0.047 0.101 0.038 0.048 D_ACov _BS 0.273 0.241 0.321 0.290 0.304 0.106 0.294 0.267 0.295 0.273 0.076 0.087 0.050 0.114 0.113 Num_ACov _BS 0.364 0.414 0.491 0.435 0.507 0.167 0.397 0.373 0.393 0.352 0.086 0.113 0.076 0.152 0.185

Panel B: Non-IFRS countries (Control sample) Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 N 17 26 11 16 18 21 24 59 87 127 132 225 254 359 299 D_ACov 0.588 0.654 0.545 0.563 0.722 0.381 0.333 0.492 0.563 0.291 0.220 0.373 0.417 0.429 0.492 Num_ ACov 1.176 1.346 1.091 1.813 1.278 0.857 0.583 1.220 1.586 0.551 0.477 0.889 1.307 1.170 1.314 D_ACov _IS 0.059 0.077 0.000 0.500 0.222 0.286 0.125 0.373 0.368 0.150 0.129 0.244 0.343 0.290 0.361 Num_ACov _IS 0.059 0.192 0.000 1.188 0.500 0.524 0.208 0.407 0.425 0.189 0.174 0.249 0.390 0.292 0.391 D_ACov _BS 0.588 0.615 0.545 0.438 0.500 0.286 0.250 0.441 0.494 0.228 0.197 0.356 0.386 0.401 0.462 Num_ACov _BS 1.118 1.154 1.091 0.625 0.778 0.333 0.375 0.814 1.161 0.362 0.303 0.640 0.917 0.877 0.923

51

Table 3: Summary statistics

This table reports summary statistics of regression variables for the pre-IFRS adoption period (fiscal years ending before December 2005; Post=0) and post-IFRS adoption period (fiscal years ending in or after December 2005; Post=1). Panel A reports statistics for the treatment sample, debt issued by firms domiciled in countries that mandated IFRS adoption in 2005. Panel B reports statistics for the control sample, debt issued by firms domiciled in countries outside the U.S. that did not have a major change in accounting regime during the sample period. The Difference column compares mean values in pre- and post-adoption periods using a t-test. The Diff-in-diff column reports mean difference-in-differences between the treatment sample (Panel A) and control sample (Panel B) using a t-test. Size is the natural logarithm of market capitalization (in US dollar millions). MTB is market capitalization to book value of equity. Leverage is total debt divided by total assets. ROA is EBITDA divided by total assets. Tangibility is net PP&E divided by total assets. D_Rating is a dummy variable indicating that credit ratings are available for the issued debt or borrower at the time of issuance. InvestGrade is a dummy variable indicating the average credit rating for the issued debt or borrower at the time of issuance is at investment grade (at or above BBB for Standard & Poor and Fitch and Baa for Moodys). Num_ACov_EXCF is the total number of accounting covenants (not including those based on cash flows. D_ACov_EXCF is one if Num_ACov_EXCF exceeds zero. See Table 2 for other variable definitions. All continuous variables are winsorized at the 1st and 99th percentiles.

Panel A: IFRS countries (Treatment sample)

Pre-IFRS adoption period Variable D_ACov Num_ACov Size MTB Leverage ROA Tangibility D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Maturity D_ACov_IS Num_ACov_IS D_ACov_BS Num_ACov_BS D_ACov_EXCF Num_ACov_EXCF N 611 611 611 611 611 611 611 611 611 611 611 611 611 611 611 611 611 611 611 Mean 0.465 0.899 8.577 3.668 0.307 0.129 0.389 0.115 0.681 0.470 1.660 5.958 104.4 0.304 0.517 0.264 0.381 0.465 0.885 Q1 0.000 0.000 7.124 1.352 0.211 0.083 0.168 0.000 0.000 0.000 0.450 5.282 57.0 0.000 0.000 0.000 0.000 0.000 0.000 Median 0.000 0.000 8.644 2.197 0.304 0.120 0.353 0.000 1.000 0.000 1.250 6.058 76.0 0.000 0.000 0.000 0.000 0.000 0.000 Q3 1.000 2.000 10.009 3.859 0.416 0.167 0.581 0.000 1.000 1.000 2.750 6.777 120.0 1.000 1.000 1.000 1.000 1.000 2.000 Std Dev 0.499 1.144 1.955 5.699 0.154 0.074 0.244 0.319 0.467 0.499 2.171 1.174 88.0 0.461 0.880 0.441 0.701 0.499 1.126 N 751 751 751 751 751 751 751 751 751 751 751 751 751 751 751 751 751 751 751 Post-IFRS adoption period Mean 0.121 0.194 9.093 2.918 0.316 0.128 0.362 0.012 0.742 0.567 2.800 5.927 107.2 0.037 0.065 0.093 0.129 0.121 0.190 Q1 0.000 0.000 7.870 1.166 0.193 0.081 0.175 0.000 0.000 0.000 0.962 5.165 60.0 0.000 0.000 0.000 0.000 0.000 0.000 Median 0.000 0.000 9.374 1.931 0.310 0.115 0.324 0.000 1.000 1.000 2.756 6.215 78.0 0.000 0.000 0.000 0.000 0.000 0.000 Q3 0.000 0.000 10.646 3.161 0.433 0.159 0.536 0.000 1.000 1.000 4.722 6.908 120.0 0.000 0.000 0.000 0.000 0.000 0.000 Std Dev 0.327 0.575 1.945 4.972 0.149 0.072 0.223 0.109 0.438 0.496 3.053 1.255 87.3 0.190 0.346 0.291 0.433 0.327 0.556 Difference (Post-Pre) Mean -0.344 -0.704 0.517 -0.750 0.008 -0.001 -0.027 -0.103 0.061 0.098 1.140 -0.032 2.7 -0.267 -0.452 -0.170 -0.252 -0.344 -0.695 t -14.66 -13.86 4.86 -2.56 1.02 -0.34 -2.13 -7.60 2.46 3.60 8.03 -0.48 0.57 -13.44 -11.96 -8.20 -7.77 -14.66 -13.93 Diff-in-diff (IFRS-NonIFRS) Mean -0.317 -0.807 0.769 0.787 0.034 0.002 0.013 -0.149 0.173 0.118 0.152 0.245 24.3 -0.332 -0.445 -0.188 -0.363 -0.312 -0.800 t -8.71 -8.81 5.01 1.33 2.84 0.38 0.72 -6.73 4.64 3.13 0.61 2.84 4.17 -10.60 -8.59 -5.49 -5.48 -8.60 -8.81

52

Table 3 (contd) Panel B: Non-IFRS countries (Control sample)

Difference (Post-Pre) Std Dev 0.493 1.509 2.099 5.128 0.154 0.071 0.237 0.352 0.500 0.459 2.421 1.165 52.9 0.457 0.515 0.488 1.123 0.491 1.510 Mean -0.027 0.103 -0.252 -1.537 -0.026 -0.003 -0.040 0.046 -0.112 -0.020 0.988 -0.277 -21.6 0.065 -0.007 0.017 0.110 -0.031 0.105 t -0.97 1.35 -2.28 -3.00 -2.95 -0.91 -3.23 2.64 -4.03 -0.77 4.78 -4.98 -6.44 2.67 -0.20 0.64 1.92 -1.13 1.39

Pre-IFRS adoption period Variable D_ACov Num_ACov Size MTB Leverage ROA Tangibility D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Maturity D_ACov_IS Num_ACov_IS D_ACov_BS Num_ACov_BS D_ACov_EXCF Num_ACov_EXCF N 428 428 428 428 428 428 428 428 428 428 428 428 428 428 428 428 428 428 428 Mean 0.442 1.021 7.815 3.658 0.368 0.113 0.516 0.098 0.586 0.322 0.441 4.976 103.8 0.231 0.325 0.371 0.696 0.435 1.005 Q1 0.000 0.000 6.477 1.061 0.271 0.076 0.364 0.000 0.000 0.000 0.613 4.456 62.0 0.000 0.000 0.000 0.000 0.000 0.000 Median 0.000 0.000 7.973 1.424 0.350 0.106 0.503 0.000 1.000 0.000 1.395 5.011 96.0 0.000 0.000 0.000 0.000 0.000 0.000 Q3 1.000 2.000 9.165 2.151 0.499 0.138 0.658 0.000 1.000 1.000 2.092 5.521 120.0 0.000 0.000 1.000 2.000 1.000 2.000 Std Dev 0.497 1.306 1.936 10.155 0.157 0.067 0.215 0.298 0.493 0.468 4.033 0.927 62.1 0.422 0.667 0.484 0.995 0.496 1.297 N 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247 1,247

Post-IFRS adoption period Mean 0.415 1.124 7.563 2.121 0.343 0.110 0.476 0.144 0.475 0.302 1.428 4.699 82.2 0.296 0.318 0.389 0.807 0.403 1.110 Q1 0.000 0.000 5.911 0.925 0.237 0.067 0.294 0.000 0.000 0.000 0.700 3.917 60.0 0.000 0.000 0.000 0.000 0.000 0.000 Median 0.000 0.000 7.717 1.365 0.332 0.098 0.475 0.000 0.000 0.000 1.140 4.702 60.0 0.000 0.000 0.000 0.000 0.000 0.000 Q3 1.000 2.000 9.246 2.003 0.465 0.136 0.679 0.000 1.000 1.000 1.803 5.521 108.0 1.000 1.000 1.000 2.000 1.000 2.000

53

Table 4: Difference-in-difference analysis of accounting covenant use

This table reports our main results for difference-in-difference regression analysis. In Panel A, we use observations from the full treatment and control samples as described in Table 1 Panels A and B. Columns (1) (3) report Probit regression coefficients on the binary variable D_ACov and columns (4) (6) report OLS regression coefficients on the natural logarithm of 1+Num_ACov. Panel B reports the regression coefficients using the constant sample, including only debt issued by firms existing in both pre- and post-IFRS adoption periods. Columns (1) (2) report Probit regression coefficients on the binary variable D_ACov and columns (3) (4) report OLS regression coefficients on the natural logarithm of 1+Num_ACov. D_ACov is a dummy variable indicating that the debt contract contains at least one accounting-based covenant. Num_ACov is the total number of accounting covenants contained in a debt contract. In Panel C, we use alternative definitions for accounting covenants. In columns Income Statement, D_ACov_IS and Log(1+Num_ACov_IS) are used as dependant variables in Probit and OLS regressions, respectively. D_ACov_IS is a dummy variable indicating that the debt contract contains at least one accounting covenant based on income statement items, such as interest coverage ratio, fixed charge ratio, debt service coverage, etc. Num_ACov_IS is the total number of accounting covenants based on income statement items. In columns Balance Sheet, D_ACov_BS and Log(1+Num_ACov_BS) are used as dependant variables in Probit and OLS regression models, respectively. D_ACov_BS is a dummy variable indicating that the debt contract contains at least one accounting covenant solely based on balance sheet items, such as current ratio, quick ratio, leverage ratio, net worth, etc. Num_ACov_BS is the total number of accounting covenants solely based on balance sheet items. In columns Ex. Cash Flow, D_ACov_EXCF and Log(1+Num_ACov_EXCF) are used as dependant variables in Probit and OLS regression models, respectively. Num_ACov_EXCF is the total number of accounting covenants excluding those based on cash flow numbers, such as cash interest coverage and cash flow to debt ratio. D_ACov_EXCF is defined as one if Num_ACov_EXCF is larger than zero. IFRS is defined as one for observations from the treatment sample and zero otherwise. Post is defined as one for fiscal years ending in or after December 2005 and zero otherwise. Size is the natural logarithm of market capitalization (in million US dollars). MTB is market capitalization to book value of equity. Leverage is total debt divided by total assets. ROA is EBITDA divided by total assets. Tangibility is net PP&E divided by total assets. USFiling is a dummy variables indicating that the firm has SEC filings available, i.e. when the firm has public equity, ADR, or debt listed in the US. Cred Rghts is an index measuring the strength of a country's creditor protection and is obtained from Djankov, McLiesh and Shleifer (2007). PrivDebt Mkt is a dummy variable indicating the importance of a countrys private long-term debt financing market and is obtained from Bushman and Piotroski (2006). Civil Law is a dummy variable indicating that the firm is incorporated in a civil law country and it is obtained from La Porta, Lopes-de Silanes, Shleifer, and Vishny (1998). D_Secured is a dummy variable indicating that the debt contract is secured. D_Rating is a dummy variable indicating that credit ratings are available for the issued debt or borrower at the time of issuance. InvestGrade is a dummy variable indicating that the average credit rating for the issued debt or borrower at the time of issuance is at the investment grade (BBB or above for Standard&Poor and Fitch and Baa or above for Moodys). Yield Spread is the yield to maturity at offering minus benchmark (country-specific riskfree rate) for bonds or all-in-drawn for private loans (in percentages). Log(Debt Size) is the natural logarithm of debt offering amount (in million US dollars). Maturity is debt maturity in number of months. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by the firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

54

Table 4 (contd) Panel A: Full sample

Probit: D_ACov OLS: Log (1+Num_ACov)

(1) Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) -0.069 (-0.44) 0.059 (0.33) -1.012*** (-6.07)

(2) -0.029 (-0.27) 0.594*** (3.32) -1.009*** (-6.23) -0.518* (-1.80) -0.314*** (-11.17) 0.035*** (8.24) 0.510 (0.84) -0.271 (-1.05) 0.089 (0.77) 0.008 (0.12) -1.201*** (-6.89) 0.785*** (3.44)

(3) -0.136 (-1.05) 0.435*** (2.59) -0.891*** (-5.54) -0.409* (-1.94) -0.216*** (-6.13) 0.029*** (7.92) 0.934 (1.34) -0.049 (-0.22) 0.042 (0.37) 0.040 (0.62) -1.177*** (-7.22) 0.841*** (3.85) 1.302*** (4.75) 0.217 (1.43) -0.902*** (-6.89) 0.043*** (2.70) 0.075 (1.55) -0.467*** (-10.17) Industry 3,037 46.6%

(4) 0.012 (0.13) -0.031 (-0.35) -0.380*** (-4.31)

(5) 0.010 (0.23) 0.150*** (3.15) -0.261*** (-6.24) -0.142 (-1.62) -0.102*** (-11.05) 0.012*** (5.02) -0.076 (-0.38) -0.001 (-0.01) 0.038 (1.20) 0.009 (0.46) -0.486*** (-8.25) 0.345*** (4.78)

(6) -0.040 (-0.83) 0.069* (1.67) -0.174*** (-4.43) -0.102 (-1.56) -0.064*** (-8.06) 0.009*** (4.79) 0.023 (0.14) 0.051 (0.78) 0.034 (1.37) 0.016 (1.07) -0.439*** (-9.33) 0.321*** (5.67) 0.411*** (10.74) 0.027 (0.61) -0.187*** (-4.90) 0.013** (2.48) 0.014 (1.36) -0.124*** (-9.09) Industry 3,037 57.1%

Fixed effects N Pseudo/Adjusted R2

No 3,037 7.0%

Industry 3,037 37.4%

No 3,037 8.5%

Industry 3,037 49.7%

55

Table 4 (contd) Panel B: Constant sample

Probit: D_ACov (1) Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) 0.218* (1.74) 0.490* (1.85) -0.759*** (-3.72) -0.832 (-1.24) -0.442*** (-6.45) 0.039*** (5.17) 0.048 (0.03) 0.019 (0.03) 0.478*** (2.94) -0.024 (-0.23) -0.996*** (-3.45) 0.523 (1.27) (2) 0.196 (1.43) 0.414 (1.41) -0.716*** (-3.38) -0.604 (-1.03) -0.257*** (-2.97) 0.029*** (4.81) 0.266 (0.18) 0.531 (0.87) 0.397** (2.10) -0.024 (-0.22) -1.042*** (-3.93) 0.494 (1.32) 1.047** (1.99) 0.007 (0.03) -1.259*** (-6.99) 0.071*** (3.14) 0.071 (1.03) -0.567*** (-7.94) Industry 1,383 52.6% OLS: Log (1+Num_ACov) (3) 0.067* (1.83) 0.059 (0.90) -0.169*** (-4.92) -0.022 (-0.12) -0.125*** (-7.18) 0.009*** (3.59) -0.068 (-0.15) 0.038 (0.20) 0.079 (1.33) 0.009 (0.34) -0.408*** (-4.14) 0.241** (1.97) (4) 0.015 (0.44) -0.011 (-0.23) -0.086*** (-4.43) 0.040 (0.26) -0.075*** (-4.25) 0.007*** (3.49) 0.144 (0.42) 0.072 (0.49) 0.072 (1.39) 0.012 (0.50) -0.359*** (-4.32) 0.153 (1.40) 0.355*** (4.73) -0.030 (-0.44) -0.282*** (-4.32) 0.017*** (2.91) 0.005 (0.42) -0.112*** (-6.03) Industry 1,383 63.1%

Fixed effects N Pseudo/Adjusted R

2

Industry 1,383 38.7%

Industry 1,383 52.3%

56

Table 4 (contd) Panel C: Alternative definitions on accounting covenants

Income Statement 0.082 (0.44) 0.490*** (2.89) -1.241*** (-7.65) 0.181 (0.46) -0.111*** (-3.75) 0.020*** (2.88) 1.309* (1.85) -0.416* (-1.90) 0.080 (0.70) 0.091 (1.55) -0.966*** (-6.39) 0.735*** (4.37) 1.041*** (6.08) -0.459*** (-3.40) -0.479** (-2.56) -0.017 (-0.65) 0.088 (1.45) -0.691*** (-9.71) Industry 3,037
2

Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

Probit: D_ACov Balance Ex. Cash Sheet Flow -0.012 -0.148 (-0.11) (-1.19) 0.164 0.503*** (1.17) (3.10) -0.621*** -0.885*** (-4.29) (-5.43) -0.588* -0.433* (-1.80) (-1.81) -0.188*** -0.227*** (-4.56) (-6.42) 0.028*** 0.030*** (6.02) (8.03) -0.331 0.602 (-0.54) (1.04) 0.452 -0.035 (1.55) (-0.15) -0.056 0.077 (-0.45) (0.62) 0.061 0.054 (1.05) (0.85) -1.233*** -1.327*** (-5.98) (-7.42) 1.032*** 1.018*** (3.55) (4.15) 0.411** 1.312*** (2.19) (4.70) 0.224* 0.203 (1.82) (1.41) -0.808*** -0.882*** (-6.04) (-7.11) 0.058*** 0.048*** (3.10) (2.86) 0.002 0.100* (0.05) (1.94) -0.178*** -0.471*** (-2.60) (-10.05) Industry 3,037 42.9% Industry 3,037 48.5%

OLS: Log (1+Num_ACov) Income Balance Ex. Cash Statement Sheet Flow -0.023 0.010 -0.041 (-0.71) (0.30) (-0.89) 0.094*** -0.012 0.072* (4.39) (-0.31) (1.80) -0.135*** -0.076** -0.170*** (-5.96) (-2.27) (-4.44) 0.049 -0.144* -0.099 (0.77) (-1.85) (-1.48) -0.017*** -0.053*** -0.064*** (-3.56) (-5.39) (-7.91) 0.004* 0.007*** 0.009*** (1.80) (3.96) (4.61) 0.231* -0.260* -0.018 (1.91) (-1.70) (-0.12) -0.062 0.143** 0.055 (-1.41) (2.07) (0.79) 0.031 0.003 0.039 (1.55) (0.10) (1.57) 0.010 0.017 0.020 (1.17) (1.52) (1.36) -0.144*** -0.401*** -0.458*** (-7.02) (-9.21) (-9.75) 0.094*** 0.331*** 0.347*** (3.71) (6.41) (6.14) 0.333*** 0.166*** 0.412*** (7.15) (3.23) (10.97) -0.072** 0.050 0.026 (-2.57) (1.36) (0.60) -0.049** -0.127*** -0.176*** (-2.16) (-4.36) (-4.86) -0.002 0.015*** 0.014*** (-0.53) (3.64) (2.77) 0.013 -0.002 0.017* (1.46) (-0.29) (1.66) -0.117*** -0.030*** -0.123*** (-7.04) (-2.58) (-8.91) Industry 3,037 40.4% Industry 3,037 52.1% Industry 3,037 58.1%

Fixed effects N Pseudo/Adjusted R

47.2%

57

Table 5: Cross-sectional analysis of accounting covenant use

For both Probit model on D_ACov and OLS model on the logarithm of 1+Num_ACov, we use only observations from the treatment sample (see Panel A of Table 1). Index takes the value of Bae Acct or FV. Bae Acct is an index measuring the difference between domestic GAAP and IFRS in terms of accounting items. It is the sum of 14 out of 21 items obtained from Table 1 of Bae, Tan, and Welker (2008). Items 1, 3, 7, 9 11, 12, and 19 are exclude for the calculation of this index as they only influence disclosures but not accounting numbers. FV is a self-constructed index measuring the difference between domestic GAAP and IFRS in terms of fair value accounting. Both Bae Acct and FV are normalized between 0 and 1.The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. See Table 4 legend for definitions on other variables. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

58

Table 5 (contd)
Probit: D_ACov Bae Acct FV -0.413* -0.521*** (-1.75) (-2.63) 0.143 0.753** (0.26) (2.24) -1.229*** -0.987*** (-4.24) (-4.50) -0.355 -0.382 (-0.85) (-0.91) -0.240*** -0.238*** (-3.97) (-3.91) 0.012 0.012 (1.44) (1.48) 0.009 0.071 (0.01) (0.09) 0.286 0.248 (1.29) (1.13) 0.238 0.259 (1.46) (1.61) -0.015 0.043 (-0.20) (0.46) -0.383** -0.391** (-2.41) (-2.45) 0.279 -0.019 (0.70) (-0.08) 1.105*** 1.153*** (3.30) (3.30) 0.301 0.271 (1.52) (1.39) -1.134*** -1.114*** (-6.69) (-6.52) 0.065** 0.065** (1.98) (1.99) 0.178*** 0.178*** (2.60) (2.63) -0.448*** -0.439*** (-9.21) (-9.00) Industry 1,362
2

Index: Post Index PostIndex Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

OLS: Log (1+Num_ACov) Bae Acct FV -0.079 -0.101* (-1.33) (-1.94) 0.182* 0.227** (1.65) (2.50) -0.272*** -0.223*** (-3.11) (-3.31) -0.076 -0.080 (-0.98) (-1.04) -0.069*** -0.070*** (-5.47) (-5.77) 0.005* 0.005** (1.95) (2.00) -0.005 0.017 (-0.02) (0.08) 0.059 0.057 (0.86) (0.86) 0.107*** 0.108*** (3.08) (3.16) -0.019 -0.014 (-1.03) (-0.72) -0.112** -0.129*** (-2.49) (-2.71) -0.041 -0.062 (-0.54) (-0.95) 0.449*** 0.453*** (6.77) (6.71) 0.110** 0.104* (2.09) (1.94) -0.280*** -0.276*** (-6.74) (-6.53) 0.011 0.011 (1.58) (1.59) 0.031** 0.032** (2.32) (2.34) -0.105*** -0.103*** (-6.38) (-6.27) Industry 1,362 45.7% Industry 1,362 45.7%

Fixed effects N Pseudo/Adjusted R

Industry 1,362 41.8%

41.9%

59

Table 6: Bonds versus loans

In this table, we split the sample into bonds and loans and report Probit regression results on D_ACov separately for the loan and bond samples under columns Loan and Bond. In columns titled Diff (Loan-Bond), we compare the coefficients across the loan and bond regressions by pooling loans and bonds in the sample regression and adding a dummy for loan and its interactions with all regression variables. In columns titled Diff-in-diff, observations from both treatment and control samples are used. In columns titled Bae Acct and FV, only observations from the treatment sample are used. Index takes the value of Bae Acct Index or FV Index. See Tables 4 and 5 legends for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively. Probit: D_ACov Diff-in-diff Loan Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling 1.380*** (2.71) 0.310 (1.13) -1.777*** (-3.03) 1.579* (1.78) 0.147* (1.69) 0.011 (0.95) -0.178 (-0.08) -1.032* (-1.72) -0.289 Bond -0.233 (-1.13) 0.167 (0.61) -0.294 (-1.12) -0.955*** (-2.93) -0.286*** (-5.64) 0.033*** (6.23) 2.210*** (2.94) 0.503** (2.28) 0.301** Diff (Loan-Bond) 1.614*** (2.73) 0.143 (0.31) -1.483** (-2.09) 2.535*** (2.58) 0.433*** (4.68) -0.022 (-1.57) -2.388 (-1.04) -1.536** (-2.44) -0.590** Post Index PostIndex Leverage Size MTB ROA Tangibility USFiling Index: Loan 1.864** (2.06) 0.129 (0.06) -4.054** (-2.24) 3.259** (2.18) 0.262 (1.31) 0.027 (1.44) -3.831* (-1.69) -1.093 (-0.98) -0.356 Bae Acct Bond -0.200 (-0.66) -1.065 (-1.27) -0.868** (-2.04) -0.361 (-0.52) -0.151* (-1.75) 0.001 (0.05) -0.087 (-0.12) 0.799*** (3.06) 0.099 Diff (Loan-Bond) 2.063** (2.53) 1.194 (0.66) -3.187* (-1.78) 3.620** (2.39) 0.412* (1.82) 0.026 (1.04) -3.744* (-1.65) -1.892* (-1.74) -0.455 Loan 4.609** (2.02) -0.000 (-0.00) -8.793*** (-3.20) 3.672*** (2.61) 0.295 (1.44) 0.025 (1.41) -3.111 (-1.37) -1.719 (-1.55) -0.580** FV Bond -0.385 (-1.31) 0.208 (0.34) -0.413 (-1.07) -0.299 (-0.43) -0.163* (-1.87) 0.002 (0.16) 0.114 (0.15) 0.670*** (2.76) 0.143 Diff (Loan-Bond) 4.992** (2.11) -0.208 (-0.15) -8.377*** (-3.11) 3.970*** (2.78) 0.457* (1.95) 0.024 (0.96) -3.226 (-1.39) -2.389** (-2.16) -0.722**

60

Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

(-1.18) -0.116 (-0.71) -0.023 (-0.09) -0.055 (-0.12) 0.420 (1.17) -0.578* (-1.80) 0.029 (0.14) -0.146 (-1.13) -0.345*** (-3.32) 0.460*** (4.82) Industry 795

(2.56) -0.065 (-0.78) -0.525** (-2.14) 0.401 (1.32) 2.168*** (3.02) 0.864*** (6.64) -1.221*** (-7.83) 0.064*** (2.84) 0.036 (0.77) -0.114 (-1.43) Industry 2,242 36.7%

(-2.05) -0.051 (-0.31) 0.502 (1.56) -0.456 (-0.94) -1.748* (-1.88) -1.442*** (-4.35) 1.250*** (4.41) -0.210 (-1.63) -0.381*** (-3.47) 0.574*** (4.29)

Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Debt Size Log(Maturity)

(-1.10) -0.392* (-1.66) 0.303 (0.76) -1.453 (-1.55) 0.487 (1.39) -1.251*** (-2.87) 0.024 (0.05) 0.041 (0.16) -0.220 (-1.38) 0.538*** (4.99) Industry 275 33.9%

(0.57) 0.013 (0.09) -0.361* (-1.73) 1.074** (2.39)

(-1.29) -0.405* (-1.70) 0.664 (1.36) -2.527** (-2.39)

1.007*** (5.27) -1.752*** (-6.98) 0.133** (2.47) 0.049 (0.56) -0.000 (-0.00) Industry 1,087 36.9%

-2.258*** (-5.37) 1.776*** (3.23) -0.092 (-0.34) -0.268 (-1.37) 0.539*** (3.32)

(-2.11) -0.436* (-1.75) 0.131 (0.26) -1.366 (-1.58) 0.386 (1.12) -1.247** (-2.55) 0.087 (0.15) 0.043 (0.17) -0.227 (-1.35) 0.496*** (5.53) Industry 275 37.1%

(0.86) 0.152 (1.12) -0.258 (-1.19) 0.426 (1.13)

(-2.53) -0.588** (-2.17) 0.389 (0.67) -1.791 (-1.64)

0.936*** (5.00) -1.711*** (-6.49) 0.130** (2.39) 0.064 (0.74) 0.021 (0.21) Industry 1,087 36.0%

-2.182*** (-4.56) 1.799*** (2.91) -0.087 (-0.34) -0.290 (-1.41) 0.475*** (3.16)

Fixed effects N Pseudo R

2

Fixed effects N Pseudo R2

35.1%

61

Table 7: Robustness analysis: country and year fixed effects

In this table, we report the Probit regression results on D_ACov after including industry, country, and year fixed effects. To avoid multicollinearity, we omit IFRS, Post, and country-level control variables from the regressions. In columns titled Diff-in-diff, observations from both treatment and control samples are used. In columns titled Bae Acct and FV, only observations from the treatment sample are used. Index takes the value of Bae Acct Index or FV Index. See Tables 4 and 5 legends for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by country and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively. Probit: D_ACov Diff-in-diff PostIFRS Leverage Size MTB ROA Tangibility USFiling D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) -0.640* (-1.80) -0.518* (-1.73) -0.156*** (-3.77) 0.012*** (2.77) 0.185 (0.25) 0.204 (1.32) 0.040 (0.34) 1.258*** (4.00) 0.389*** (2.86) -0.833*** (-5.99) 0.098*** (3.52) 0.090 (1.49) -0.481*** (-10.55) Industry, year, and country 3,037
2

Index: PostIndex Leverage Size MTB ROA Tangibility USFiling D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

Bae Acct -0.894** (-2.47) -0.348 (-0.98) -0.266*** (-3.12) 0.016** (2.49) -0.466 (-0.53) 0.174 (0.70) 0.396*** (2.59) 1.163*** (3.44) 0.226 (1.47) -1.118*** (-7.24) 0.085** (2.25) 0.213*** (4.00) -0.437*** (-10.15) Industry, year, and country 1,362

FV -0.648* (-1.92) -0.339 (-0.97) -0.266*** (-3.15) 0.016** (2.45) -0.423 (-0.49) 0.158 (0.63) 0.401** (2.52) 1.183*** (3.33) 0.206 (1.31) -1.090*** (-6.96) 0.086** (2.28) 0.212*** (4.03) -0.432*** (-9.86) Industry, year, and country 1,362 44.7%

Fixed effects

Fixed effects

N Pseudo R

N Pseudo R
2

55.2%

44.9%

62

Table 8: Use of non-accounting covenants

In Panel A, we report difference-in-difference regression results on the use of non-accounting covenants as well as on the ratio of accounting to non-accounting covenants. Covenants on dividend restriction, investment restriction, asset sale restriction, equity issue restriction, and debt issue restriction are common to both loan and bond contracts. Columns Dividend Rstr, Investment Rstr, Asset sale Rstr, Equity Issue Rstr, and Debt Issue Rstr report the Probit regression results on D_Cov, which is defined as one if the debt contract contains at least one non-accounting covenant from the specified type, and zero otherwise. Column Four_NACov (Or. Logit) presents ordered Logit regression results where the dependant variable is the sum of four dummy variables Investment Rstr, Asset sale Rstr, Equity Issue Rstr, and Debt Issue Rstr. For these types of covenants, both loan and bond samples are used. Covenant on prepayment restriction is specific to loan contracts. Column Prepayment Rstr reports the Probit regression results on D_Cov, which is defined as one if the loan contract contains at least one prepayment restriction, and zero otherwise. For this regression, only observations from the loan sample are used. Covenants on cross default provision, merger restriction, and prior claim restriction are specific to bond contracts. Columns Cross Default, Merger Rstr, and Prior Claim Rstr report the Probit regression results on D_Cov, which is defined as one if the bond contract contains at least one covenant from the specified type, and zero otherwise. For these types of covenants, only observations from the bond sample are used. The ratio of accounting to nonaccounting covenants are measured either as (1+Num_ACov)/(1+Four_NACov) or as (1+Num_ACov)/(1+Num_NACov), where Num_NACov are defined as total number of covenants minus the number of accounting covenants Num_ACov. In this panel, the regressions include observations from both treatment and control samples. In Panel B, we report results from regression of either Four_NACov or the ratio of accounting covenants to non-accounting covenants as defined in Panel A on Index, which measures the differences between prior local GAAP and IFRS. In columns titled Bae Acct and FV, Index takes the value of Bae Acct Index or FV Index. In this panel, only observations from IFRS countries are included. See Tables 4 and 5 legends for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

63

Table 8 (contd) Panel A: Difference-in-difference analysis

Probit: D_Cov

OLS: Ratio of accounting to nonaccounting covenants

All Debt

Loan

Bond

All Debt

Dividend Rstr Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling -0.570** (-2.11) -0.229 (-1.42) -0.249 (-1.14) -0.329 (-1.21) -0.234*** (-4.37) 0.021*** (4.02) 1.102 (1.60) -0.373 (-1.17) 0.509*** (3.33)

Investment Rstr -2.289*** (-3.85) -0.285 (-0.90) 1.843** (2.37) 1.320* (1.80) 0.030 (0.30) 0.020** (2.41) -0.705 (-0.51) -3.395*** (-6.44) 0.011 (0.04)

Asset Sale Rstr -0.404** (-2.09) 0.258** (2.01) -0.284** (-2.30) 0.107 (0.36) -0.156*** (-3.90) 0.015*** (2.92) 2.324*** (3.57) -0.338 (-1.52) 0.425*** (3.81)

Equity Issue Rstr -0.905** (-2.45) 0.151 (0.89) 0.703* (1.78) -0.718 (-1.64) -0.248*** (-4.68) 0.006 (0.58) 2.074* (1.70) 0.288 (0.65) 0.243 (1.46)

Debt Issue Rstr -0.594* (-1.79) 0.375 (1.26) 0.464 (1.19) -0.460 (-0.98) -0.311*** (-3.71) 0.015 (1.36) 1.627 (1.43) -0.212 (-0.37) 0.567*** (3.23)

Four_NACov (Or. Logit) -2.006*** (-3.24) 0.181 (0.37) 1.172** (2.15) -0.406 (-0.84) -0.106 (-0.98) 0.016** (2.09) 3.251*** (2.78) -0.794 (-1.21) 0.880*** (2.81)

Prepayment Rstr -0.143 (-0.19) 3.146*** (2.91) 2.964** (2.46) 3.448* (1.67) -0.114 (-0.66) 0.019 (0.67) -5.912** (-2.17) -1.153 (-0.64) -0.788 (-1.14)

Cross Default 0. 114 (0.59) 0.291 (1.47) -0.253 (-0.92) -1.028*** (-3.33) -0.002 (-0.05) 0.011 (1.31) -0.475 (-0.61) 0.314 (1.26) -0.078 (-0.72)

Merger Rstr -0.290* (-1.92) 0.326* (1.76) 0.650*** (3.33) -0.764** (-2.10) -0.389*** (-7.91) 0.033*** (4.57) 1.881** (2.28) -0.106 (-0.41) 0.647*** (4.02)

Prior Claim Rstr -0.226 (-1.30) -0.234 (-1.05) -0.229 (-1.06) -0.023 (-0.08) -0.097** (-2.12) -0.001 (-0.16) 1.392** (2.21) -0.029 (-0.09) 0.449*** (3.33)

1+Num_ACov 1+ Four_NACov 0.698** (2.45) -0.346 (-1.29) -0.549** (-2.06) 0.012 (0.05) -0.055 (-1.51) 0.005 (1.26) -0.978 (-1.43) 0.294 (1.40) -0.300** (-2.49)

1+Num_ACov 1+Num_NACov 0.297** (2.13) 0.130 (1.10) -0.364*** (-3.29) 0.051 (0.33) -0.044* (-1.83) 0.004 (1.31) -0.599 (-1.50) 0.085 (0.47) -0.298*** (-3.19)

64

Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

-0.193*** (-4.58) 0.771*** (5.44) -1.105*** (-5.62) 0.644*** (3.22) 1.069*** (11.35) -1.218*** (-8.74) 0.038* (1.69) 0.035 (0.59) -0.180** (-2.07) Industry 3,037

0.060 (0.44) 0.290 (0.67) -0.242 (-0.53) 0.505* (1.92) 0.825*** (4.11) -1.720*** (-3.23) 0.132*** (3.83) -0.390*** (-4.71) -0.060 (-0.42) Industry 1,288 48.4%

-0.218*** (-4.37) -0.119 (-0.84) -0.672*** (-5.30) -0.054 (-0.29) 0.579*** (3.98) -0.304** (-2.48) 0.023 (1.45) 0.115** (2.04) 0.154*** (2.89) Industry 3,037 28.1%

-0.267** (-2.49) 0.332* (1.70) -0.169 (-0.67) 0.513** (2.12) 0.885*** (5.16) -0.849*** (-3.01) 0.084** (2.13) 0.260*** (3.30) 0.029 (0.38) Industry 1,288 38.4%

-0.263*** (-2.60) 0.226 (1.33) -0.425 (-1.57) 0.326 (1.27) 0.951*** (3.93) -0.949*** (-5.70) 0.031 (0.98) 0.340** (2.38) -0.087 (-0.91) Industry 1,288 34.4%

-0.407** (-2.49) 0.454 (1.14) -1.087*** (-2.78) 0.729* (1.83) 1.610*** (4.83) -1.059*** (-4.04) 0.048 (1.28) 0.213 (1.64) 0.420*** (4.03) Industry 1,288 28.5%

-1.104** (-2.25) -1.722* (-1.76) -2.479** (-2.35) 3.341*** (5.25) 1.508** (2.26) 1.535* (1.72) 1.209*** (3.85) -0.095 (-0.73) 2.520*** (2.78) Industry 795 79.1%

0.095** (2.03) -0.134 (-1.19) 0.850*** (4.77) 0.718* (1.70) 0.406*** (3.48) -0.145 (-0.72) -0.022** (-2.19) 0.202*** (6.05) -0.056 (-0.90) Industry 2,242 13.5%

-0.300*** (-6.84) -1.068*** (-7.53) -0.322** (-2.14)

0.540*** (3.41) -0.665*** (-3.12) 0.011 (0.55) 0.323*** (4.18) -0.126 (-1.62) Industry 2,374 42.2%

0.039 (0.62) 0.159 (1.03) 0.089 (0.59) 0.806** (2.14) 0.184* (1.88) 0.054 (0.36) 0.009 (0.65) 0.036 (0.81) -0.020 (-0.22) Industry 2,374 11.5%

0.262*** (3.65) -0.501*** (-3.86) 0.893*** (5.20) 0.150 (1.50) -0.509*** (-3.66) -0.194 (-1.47) 0.021 (1.34) -0.044 (-0.84) -0.265*** (-5.88) Industry 1,288 67.9%

0.142*** (3.97) -1.229*** (-9.96) 1.116*** (9.30) 0.831*** (4.26) -0.586*** (-5.53) 0.216** (2.47) -0.011 (-0.72) -0.017 (-0.63) -0.192*** (-5.96) Industry 3,037 62.5%

Fixed effects N Pseudo R

2

38.3%

65

Table 8 (contd) Panel B: Cross-sectional analysis of non-accounting versus accounting covenants for IFRS countries
Bae Acct Dependent variable: Four_NACov Ordered Logit Post IFRS PostIndex Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) -1.285*** (-2.88) -0.707 (-0.66) 1.351** (2.41) 0.136 (0.22) -0.098 (-0.80) 0.018 (0.88) 3.174** (2.14) -0.712 (-0.92) 0.978*** (2.89) -0.276* (-1.80) 0.492 (1.13) -1.059 (-1.61) 1.022* (1.86) 1.472*** (2.93) -1.195*** (-3.00) 0.182** (2.34) 0.132 (0.92) 0.137 (1.27) Industry 619 17.4% -1.172*** (-2.73) -0.606 (-0.64) 1.097 (1.58) 0.069 (0.11) -0.111 (-0.88) 0.019 (0.92) 2.992** (2.02) -0.756 (-1.01) 0.999*** (2.90) -0.267 (-1.60) 0.558 (1.12) -1.083** (-2.06) 0.994* (1.69) 1.500*** (2.87) -1.216*** (-2.93) 0.181** (2.32) 0.140 (0.98) 0.145 (1.39) Industry 619 17.4% FV Bae Acct 1+Num_ACov 1+Num_ACov 1+ Four_NACov 1+Num_NACov OLS OLS 0.262*** (3.01) 0.345 (0.83) -0.334 (-1.33) 0.199 (0.90) -0.076* (-1.70) 0.009 (1.33) -1.618*** (-3.15) 0.331 (1.36) -0.283** (-2.28) 0.059 (1.22) -0.309*** (-2.84) 0.216 (0.96) 0.067 (0.46) -0.295 (-1.58) -0.278** (-2.33) -0.036* (-1.79) 0.014 (0.22) -0.190*** (-3.25) Industry 619 32.4% -0.052 (-0.71) 0.651** (2.54) -0.312** (-2.36) -0.008 (-0.08) -0.013 (-0.71) -0.001 (-0.24) -0.242 (-0.82) 0.204 (1.48) -0.124 (-1.49) 0.031* (1.67) -0.205** (-2.18) -0.059 (-0.54) 0.063 (0.96) -0.177* (-1.88) -0.025*** (-7.20) -0.023*** (-2.71) 0.002 (0.05) -0.126*** (-3.11) Industry 1,362 24.8% FV 1+Num_ACov 1+ Four_NACov OLS 0.278*** (3.47) 0.007 (0.03) -0.397** (-2.11) 0.241 (1.11) -0.072 (-1.62) 0.009 (1.25) -1.583*** (-3.02) 0.377 (1.40) -0.307** (-2.49) 0.031 (0.57) -0.305** (-2.45) 0.362** (2.40) 0.057 (0.38) -0.297 (-1.57) -0.280** (-2.28) -0.037* (-1.77) 0.010 (0.16) -0.192*** (-3.30) Industry 619 32.5% 1+Num_ACov 1+Num_NonACov OLS -0.032 (-0.48) 0.536** (2.49) -0.367*** (-3.74) -0.035 (-0.33) -0.009 (-0.50) -0.001 (-0.18) -0.228 (-0.78) 0.228* (1.70) -0.139* (-1.65) 0.015 (0.63) -0.268** (-2.47) 0.015 (0.15) 0.066 (1.03) -0.185* (-1.82) -0.019 (-1.18) -0.022*** (-2.67) 0.001 (0.02) -0.126*** (-3.17) Industry 1,362 25.1%

Fixed effects N R2

66

Table 9: Matching pre-adoption and post-adoption firms

This table reports the difference-in-difference regression results from matching issuing firms in the preadoption period with those in the post-adoption period. In columns By Size&MTB (Lev), we match each issuing firm-year in the pre-adoption period with one in the post-adoption period by size decile and market-to-book (leverage) decile. If multiple matching firm-years are found within the same size and market-to-book decile, the one with the closest size and market-to-book (leverage) is kept. The matching is done separately for the treatment and control samples. We use only debt issued by firmyears that have matches in the regressions. See Table 4 legend for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively. Probit: D_ACov By Size&MTB By Size&Lev -0.178 -0.189 (-1.12) (-1.26) 0.430** 0.543** (2.37) (2.56) -0.850*** -0.955*** (-5.15) (-4.29) -0.369 0.245 (-1.23) (0.65) -0.188*** -0.230*** (-3.68) (-4.72) 0.006*** 0.004*** (5.69) (6.41) 0.382 0.653 (0.66) (1.08) 0.043 0.035 (0.13) (0.14) -0.038 -0.008 (-0.34) (-0.08) -0.034 -0.053 (-0.56) (-1.17) -1.166*** -0.944*** (-5.53) (-3.90) 0.592** 0.423 (2.02) (1.64) 1.379*** 1.197*** (3.64) (3.41) 0.298* 0.343* (1.67) (1.78) -0.932*** -0.968*** (-6.45) (-5.98) 0.046** 0.034* (2.02) (1.68) 0.124* 0.060 (1.68) (0.81) -0.390*** -0.447*** (-6.69) (-7.29) Industry 2,043 43.4% Industry 1,999 42.0% OLS: Log (1+Num_ACov) By Size&MTB By Size&Lev -0.050 -0.079 (-0.85) (-1.38) 0.069 0.096* (1.56) (1.88) -0.187*** -0.166*** (-4.09) (-3.10) -0.090 0.081 (-1.02) (0.92) -0.066*** -0.070*** (-5.99) (-6.94) 0.002*** 0.001*** (4.04) (4.12) -0.073 0.026 (-0.42) (0.13) 0.030 0.039 (0.35) (0.52) 0.042* 0.030 (1.78) (1.16) -0.008 -0.004 (-0.61) (-0.26) -0.431*** -0.352*** (-6.94) (-5.65) 0.256*** 0.206*** (2.79) (3.02) 0.415*** 0.433*** (7.15) (5.92) 0.106** 0.102** (2.10) (2.06) -0.227*** -0.248*** (-6.54) (-7.13) 0.014** 0.011* (2.36) (1.67) 0.019 0.009 (1.25) (0.58) -0.104*** -0.113*** (-5.61) (-5.61) Industry 2,043 50.9% Industry 1,999 49.1%

Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

Fixed effects N Pseudo/Adjusted R2

67

Table 10: IV regressions on endogenous debt features

This table reports the IV approach for the difference-in-difference regression in Table 4 Panel A. In each model, one of the following five variables D_Secured, InvestGrade, Yield Spread, Log(Debt Size), and Log(Maturity) is treated as an endogenous variable. We use Ind(D_Secured) and Ctry(D_Secured) as the instruments for D_Secured, Ind(InvestGrade) and Ctry(InvestGrade) as the instruments for InvestGrade, Ind(Yield Spread) and Ctry(Yield Spread) as the instruments for Yield Spread, Ind(Debt Size) and Ctry(Debt Size) as the instruments for Debt Size, and Ind(Maturity) and Ctry(Maturity) as the instruments for Maturity. Ind(D_Secured)/Ind(InvestGrade)/Ind(Yield Spread)/Ind(Debt Size)/Ind(Maturity) is the sample mean of variable D_Secured/InvestGrade/Yield Spread/Debt Size/Maturity for all debt issued by firms in the same industry (two-digit SIC) and year. Ctry(D_Secured)/Ctry(InvestGrade)/Ctry(Yield Spread)/Ctry(Debt Size)/Ctry(Maturity) is the sample mean of variable D_Secured/InvestGrade/Yield Spread/Debt Size/Maturity for all debt issued in the same country over the six-month period prior to the current debt issuance. A minimum of three observations are required for calculating the sample means. Bond and loan samples are used separately for this calculation. This table reports first stage regression results on endogenous variables and second stage IV regression results on D_ACov and Log(1+Num_ACov), as well as partial R2 and KleibergenPaap Wald rk F-statistics for the instrument variables. In the first stage regressions, Probit model is used for D_Secured and InvestGrade and OLS model is used for Yield Spread, Log(Debt Size), and Log(Maturity). See Table 4 legend for definitions on other variables. Standard errors are clustered by both firm and year for all regressions except the IV regressions on D_ACov (second stage), where standard errors are only clustered by firm. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

68

Table 10 (contd)
Endogenous Var: First stage Dependent Var: Post IFRS Post*IFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_ Secured 0.108 (0.34) 0.236 (0.72) -0.892** (-2.21) -0.786 (-1.40) -0.134*** (-2.81) 0.006 (0.52) -0.117 (-0.12) 0.061 (0.15) 0.322** (2.55) 0.025 (0.26) 0.238 (1.23) -0.182 (-0.93) D_Secured Second stage D_ ACov -0.152 (-1.50) 0.128 (0.94) -0.268* (-1.73) -0.165 (-0.70) -0.070** (-2.03) 0.014*** (3.28) 0.775 (1.32) -0.037 (-0.17) -0.074 (-0.71) -0.015 (-0.41) -0.526*** (-4.41) 0.375*** (2.64) Log(1+Num _ACov) -0.091 (-1.06) -0.012 (-0.15) -0.036 (-0.50) -0.063 (-0.59) -0.026** (-2.06) 0.007*** (3.38) 0.120 (0.58) 0.034 (0.44) -0.023 (-0.76) -0.002 (-0.15) -0.294*** (-6.16) 0.211*** (4.35) InvestGrade Second stage D_ ACov -0.001 (-0.01) 0.306* (1.88) -0.477*** (-2.86) -0.324 (-1.02) 0.075 (1.39) -0.013* (-1.88) 1.104* (1.83) -0.112 (-0.46) 0.133 (1.03) 0.123** (2.49) -0.527*** (-3.89) 0.488*** (3.20) Log(1+Num _ACov) -0.008 (-0.11) 0.112 (1.31) -0.161 (-1.64) -0.256 (-1.53) 0.060** (2.13) -0.009*** (-2.76) 0.432 (1.55) 0.051 (0.39) 0.101 (1.50) 0.086*** (3.45) -0.393*** (-6.24) 0.349*** (4.40) Yield Spread Second stage D_ ACov 0.032 (0.26) 0.599*** (3.42) -0.916*** (-4.82) -0.269 (-0.90) -0.233*** (-6.40) 0.019*** (3.82) 0.576 (0.79) -0.094 (-0.36) 0.003 (0.02) -0.003 (-0.07) -1.017*** (-7.08) 0.620*** (3.35) Log(1+Num _ACov) 0.002 (0.04) 0.128*** (2.93) -0.180*** (-5.27) -0.078 (-1.18) -0.074*** (-8.48) 0.006*** (3.23) -0.089 (-0.52) 0.039 (0.55) 0.018 (0.68) 0.005 (0.37) -0.410*** (-7.68) 0.261*** (4.53)

First stage InvestGrade -0.519*** (-4.83) -0.310 (-1.55) 0.038 (0.21) -1.110 (-1.54) 0.510*** (4.99) -0.046*** (-5.24) 2.724** (2.46) 0.628 (1.24) 0.110 (0.58) 0.229*** (3.80) 0.056 (0.27) 0.063 (0.31)

First stage Yield Spread -0.114 (-0.68) 1.071*** (4.54) -0.723 (-1.27) 0.223 (0.48) -0.174*** (-3.20) -0.015 (-1.49) -1.948** (-2.58) -0.201 (-0.71) -0.324** (-2.33) -0.028 (-0.45) 0.807*** (2.71) -0.088 (-0.26)

69

D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) Ind(D_Secured) Ctry(D_Secured) Ind(InvestGrade) Ctry(InvestGrade) Ind(Yield Spread) Ctry(Yield Spread) 0.309* (1.95) -0.270 (-1.23) 0.097*** (2.61) 0.075 (1.31) 0.080 (0.85) 3.781*** (8.86) 2.893*** (4.08)

3.502*** (18.49) 0.163 (1.44) -0.548*** (-4.84) 0.021* (1.94) 0.044 (1.14) -0.151*** (-2.87)

1.777*** (9.13) 0.047 (0.84) -0.179*** (-4.88) 0.010** (2.20) 0.017 (1.29) -0.069*** (-4.80)

-0.280 (-0.78)

-0.017 (-0.83) -0.077 (-0.96) -0.097 (-1.29)

0.593*** (3.76) 1.408*** (10.14) -3.196*** (-18.71) 0.017 (1.27) -0.044 (-0.97) -0.129** (-2.33)

0.395*** (6.27) 0.823*** (5.47) -1.875*** (-6.98) 0.007 (0.71) -0.038* (-1.92) -0.062** (-2.32)

0.845*** (5.82) 0.677*** (3.55) -0.627*** (-3.97)

-0.005 (-0.06) 0.181 (1.33)

1.237*** (6.46) 0.249* (1.85) -0.855*** (-6.12) -0.058** (-2.43) 0.088** (1.96) -0.410*** (-5.91)

0.416*** (10.86) 0.052 (1.07) -0.197*** (-5.27) -0.023* (-1.96) 0.020 (1.62) -0.118*** (-8.17)

2.515*** (14.49) 1.613*** (5.89) 0.443*** (6.24) 0.562*** (8.47) Industry Industry 17.2% 64.59 2,979 2,979 2,979 2,979 Industry Industry Industry 6.6% 61.10 2,979 2,979 2,979 Industry Industry Industry 33.5% 122.25 2,979 2,979 Industry

Fixed effects Partial R2 KleibergenPaap Wald rk F statistic N

70

Table 10 (contd)
Endogenous Var: First stage Dependent Var: Post IFRS Post*IFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured Log (Debt Size) -0.227*** (-3.14) 0.522*** (5.76) -0.053 (-0.54) -0.010 (-0.05) 0.339*** (15.17) -0.019*** (-4.46) 0.852** (2.17) -0.006 (-0.04) 0.148** (2.41) -0.077*** (-3.18) -0.018 (-0.17) -0.015 (-0.17) -0.027 Log (Debt Size) Second stage D_ ACov 0.035 (0.30) -0.132 (-0.50) -0.657*** (-2.68) -0.219 (-0.81) -0.432*** (-8.98) 0.036*** (5.47) -0.007 (-0.01) -0.051 (-0.22) -0.084 (-0.70) 0.103** (2.28) -0.882*** (-4.22) 0.662*** (3.43) 0.949*** Log(1+Num _ACov) -0.028 (-0.59) 0.065 (0.84) -0.186*** (-4.22) -0.116* (-1.85) -0.073** (-2.06) 0.009*** (3.76) 0.050 (0.26) 0.047 (0.72) 0.035 (1.16) 0.018 (1.25) -0.434*** (-9.25) 0.317*** (5.92) 0.410*** First stage Log (Maturity) -0.120*** (-2.69) 0.014 (0.25) 0.028 (0.41) 0.058 (0.99) 0.009 (0.60) -0.002 (-0.95) 0.212 (1.64) 0.143** (2.14) 0.002 (0.06) 0.005 (0.42) -0.095*** (-3.03) 0.021 (0.53) 0.064 Log (Maturity) Second stage D_ ACov -0.212* (-1.91) 0.253 (1.60) -0.527*** (-2.85) -0.203 (-0.81) -0.148*** (-4.37) 0.018*** (3.80) 0.854 (1.40) 0.229 (1.02) 0.039 (0.36) 0.015 (0.37) -0.850*** (-6.79) 0.578*** (3.77) 0.834*** Log(1+Num _ACov) -0.090 (-1.63) 0.025 (0.57) -0.098* (-1.82) -0.076 (-1.15) -0.055*** (-5.24) 0.008*** (3.99) 0.077 (0.41) 0.168*** (2.68) 0.030 (1.23) 0.015 (1.20) -0.420*** (-8.75) 0.291*** (5.01) 0.346***

71

D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) Ind(Debt Size) Ctry(Debt Size) Ind(Maturity) Ctry(Maturity)

(-0.45) 0.442*** (5.04) -0.243*** (-2.90) 0.006 (0.52)

-0.034 (-0.76) 0.001*** (5.40) 0.000*** (6.24)

(3.53) -0.201 (-1.15) -0.507** (-2.35) 0.025 (1.42) 0.821*** (4.11) -0.268** (-2.45)

(10.88) 0.020 (0.35) -0.184*** (-4.60) 0.013** (2.50) 0.035 (0.38) -0.118*** (-9.23)

(1.33) 0.087** (2.37) 0.081** (2.22) 0.012 (1.56) 0.007 (0.35)

(4.53) 0.407*** (3.55) -0.637*** (-5.40) 0.038*** (2.74) 0.016 (0.38) -1.297*** (-15.93)

(7.67) 0.106** (2.50) -0.144*** (-4.26) 0.014** (2.17) -0.000 (-0.01) -0.490*** (-7.88)

0.007*** (12.00) -0.001*** (-6.51) Industry Industry 1.4% 48.58 2,979 2,979 2,979 2,979 Industry Industry Industry 17.0% 102.43 2,979 2,979 Industry

Fixed effects Partial R2 KleibergenPaap Wald rk F statistic N

72

Table 11: Announcement effect and different adoption windows

This table reports difference-in-difference regression results for the Probit model on D_ACov and OLS model on the natural logarithm of 1+Num_ACov. We use observations from both treatment and control samples. In columns titled Announ. Effect, we include an additional dummy PostAnnoun and its interaction with IFRS dummy to examine the announcement effect. PostAnnoun is a dummy variable indicating post-announcement period. It is equal to one for fiscal years ending in or after December 2002, and zero otherwise. We exclude countries in the treatment sample that announced IFRS adoption in years other than 2002 (see Table 1). In columns One-year window, Two-year window, and Three-year window, we keep only debt issued within these adoption windows. One-year window includes fiscal years ending between December 2004 and November 2006, two-year window includes fiscal years ending between December 2003 and November 2007, and three-year window includes fiscal years ending between December 2002 and November 2008. See Table 4 legend for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

73

Table 11 (contd)

Probit: D_ACov Announ. Effect 0.103 (0.48) -0.141 (-0.98) 0.332 (1.50) 0.364 (1.38) -1.151*** (-5.71) -0.470* (-1.87) -0.239*** (-7.03) 0.032*** (7.88) 1.011 (1.40) 0.106 (0.52) 0.106 (0.98) 0.043 (0.66) -1.176*** One-year Window Two-year Window Three-year Window Announ. Effect 0.037 (0.44) -0.048 (-0.75) 0.058 (1.10) 0.046 (0.72) -0.207*** (-5.39) -0.112 (-1.47) -0.068*** (-8.27) 0.010*** (4.99) 0.017 (0.09) 0.068 (1.05) 0.044* (1.71) 0.017 (1.12) -0.434***

OLS: Log (1+Num_ACov) One-year Window Two-year Window Three-year Window

PostAnnoun Post IFRS PostAnnounIFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt

-0.258 (-1.17) 1.632*** (4.02)

-0.117 (-0.71) 1.086*** (8.60)

-0.202 (-1.08) 0.783** (2.31)

0.056*** (3.58) 0.178*** (9.46)

-0.001 (-0.01) 0.155*** (6.13)

-0.017 (-0.27) 0.133** (2.47)

-0.865*** (-2.93) -1.771*** (-4.15) -0.502*** (-7.20) 0.007*** (6.90) 4.058*** (8.51) 1.817*** (4.13) 0.487* (1.70) 0.039 (0.09) -1.722***

-1.132*** (-5.72) -0.757*** (-3.11) -0.316*** (-4.41) 0.005*** (8.79) 3.180*** (4.50) 0.624** (2.29) -0.004 (-0.02) 0.035 (0.26) -1.518***

-0.980*** (-4.22) -0.999*** (-4.12) -0.285*** (-5.76) 0.027*** (4.26) 2.559*** (4.27) 0.294 (0.84) -0.027 (-0.16) 0.026 (0.30) -1.536***

-0.166*** (-15.33) -0.001 (-0.02) -0.069*** (-12.29) 0.001*** (3.87) 0.875* (1.88) 0.242*** (3.33) 0.139*** (5.06) 0.010 (0.30) -0.308***

-0.172*** (-4.33) -0.076 (-0.66) -0.074*** (-4.73) 0.001*** (3.86) 0.492*** (3.03) 0.183*** (3.39) 0.051 (0.99) 0.012 (0.49) -0.484***

-0.189*** (-4.32) -0.108 (-1.11) -0.066*** (-6.10) 0.006** (2.25) 0.300 (1.08) 0.122* (1.81) 0.033 (0.78) 0.001 (0.08) -0.523***

74

Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity)

(-7.38) 0.888*** (4.16) 1.311*** (4.76) 0.221 (1.43) -0.923*** (-6.71) 0.043*** (2.66) 0.074 (1.52) -0.468*** (-9.19) Industry 2,987
2

(-7.62) 0.618 (0.81)

0.218 (0.86) -2.506*** (-6.58) 0.115*** (4.13) 0.274*** (4.22) -0.920*** (-4.71) Industry 462 58.3%

(-10.54) 0.586* (1.76) 1.986*** (3.35) 0.358*** (3.95) -1.100*** (-3.55) 0.090*** (3.32) 0.196*** (3.42) -0.498*** (-10.31) Industry 979 54.3%

(-6.66) 0.724*** (2.64) 1.516*** (2.62) 0.155 (0.92) -1.102*** (-5.05) 0.063* (1.96) 0.215*** (4.49) -0.509*** (-11.19) Industry 1,500 57.0%

(-9.07) 0.320*** (5.69) 0.410*** (10.79) 0.026 (0.56) -0.184*** (-4.82) 0.012** (2.38) 0.015 (1.43) -0.123*** (-8.62) Industry 2,987 57.6%

(-4.73) 0.093 (0.60) 0.421*** (4.63) 0.011 (0.28) -0.190*** (-3.51) 0.032*** (3.40) 0.007 (0.41) -0.162*** (-8.54) Industry 462 59.1%

(-13.63) 0.237*** (3.53) 0.305*** (3.08) 0.046*** (3.28) -0.153** (-1.99) 0.030*** (3.52) 0.026 (1.48) -0.137*** (-5.82) Industry 979 59.0%

(-9.07) 0.303*** (3.86) 0.371*** (5.54) -0.030 (-0.52) -0.149** (-2.37) 0.021** (2.48) 0.030*** (2.69) -0.128*** (-6.72) Industry 1,500 63.3%

Fixed effects N Pseudo/Adjusted R

47.6%

75

Table 12: Enforcement effect

This table reports regression results for the Probit model on D_ACov and OLS model on the logarithm of 1+Num_ACov. Only observations from the treatment sample are used. In Panel A, Index takes the value of Bae Acct Index or FV Index. PostTPD is defined as one for fiscal years ending after Transparency Directive date, and zero otherwise. The date when Transparency Directive came into force for each sample country is reported in Table 1. PostTPD is set as zero for firms in the treatment sample without Transparency Directive. In Panels B, Index takes the value of Rule of Law or Regulatory Quality, two measures for legal enforcement, and are obtained from Kaufmann, Kraay, and Mastruzzi (2009). See Tables 4 and 5 legends for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

76

Table 12 (contd) Panel A: Transparency Directive

Probit: D_ACov Index: Post Index PostIndex PostTPD PostTPDIndex Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) Bae Acct -0.426 (-1.61) 0.185 (0.33) -1.080*** (-2.75) -0.008 (-0.04) -0.248 (-0.79) -0.341 (-0.82) -0.238*** (-3.97) 0.012 (1.43) -0.002 (-0.00) 0.296 (1.35) 0.236 (1.46) -0.011 (-0.15) -0.380** (-2.41) 0.254 (0.63) 1.085*** (3.29) 0.302 (1.52) -1.135*** (-6.76) 0.073** (2.18) 0.181*** (2.60) -0.454*** (-9.27) Industry 1,362
2

OLS: Log (1+Num_ACov) Bae Acct -0.050 (-0.80) 0.199* (1.77) -0.293*** (-2.80) -0.049 (-1.04) 0.028 (0.46) -0.072 (-0.95) -0.069*** (-5.50) 0.005** (1.97) -0.012 (-0.06) 0.058 (0.84) 0.106*** (3.03) -0.017 (-0.91) -0.113** (-2.46) -0.048 (-0.62) 0.446*** (6.87) 0.109** (2.07) -0.279*** (-6.70) 0.012 (1.65) 0.031** (2.29) -0.106*** (-6.22) Industry 1,362 45.7% FV -0.076 (-1.37) 0.229*** (2.60) -0.237*** (-2.84) -0.042 (-0.85) 0.008 (0.14) -0.075 (-0.98) -0.068*** (-5.73) 0.005** (1.99) 0.011 (0.05) 0.058 (0.88) 0.107*** (3.12) -0.013 (-0.71) -0.130*** (-2.70) -0.063 (-0.93) 0.449*** (6.82) 0.104* (1.93) -0.275*** (-6.51) 0.013* (1.67) 0.031** (2.29) -0.105*** (-6.15) Industry 1,362 45.7%

FV -0.642*** (-2.65) 0.785** (2.36) -0.629* (-1.84) 0.112 (0.49) -0.529 (-1.57) -0.369 (-0.89) -0.235*** (-3.89) 0.012 (1.46) 0.049 (0.06) 0.262 (1.18) 0.249 (1.55) 0.046 (0.50) -0.405** (-2.53) -0.028 (-0.11) 1.131*** (3.29) 0.273 (1.39) -1.115*** (-6.55) 0.076** (2.32) 0.184*** (2.64) -0.447*** (-9.17) Industry 1,362 41.9%

Fixed effects N Pseudo/Adjusted R

42.0%

77

Table 12 (contd) Panel B: Legal enforcement

Probit: D_ACov Index: Post Index PostIndex Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) Rule of Law -0.815** (-2.29) 0.111 (0.57) -0.126 (-0.47) -0.334 (-0.84) -0.256*** (-4.18) 0.012 (1.27) 0.200 (0.26) 0.199 (0.86) 0.292* (1.87) 0.012 (0.12) -0.416** (-2.36) 0.221 (1.02) 1.137*** (3.31) 0.290 (1.52) -1.117*** (-6.87) 0.060* (1.81) 0.184*** (2.72) -0.428*** (-8.23) Industry 1,362
2

Regulatory Quality -1.186** (-2.08) 0.050 (0.14) 0.140 (0.32) -0.352 (-0.86) -0.255*** (-4.12) 0.012 (1.30) 0.250 (0.33) 0.200 (0.84) 0.291* (1.85) 0.002 (0.01) -0.396** (-2.30) 0.189 (0.85) 1.155*** (3.32) 0.295 (1.53) -1.122*** (-6.80) 0.060* (1.83) 0.186*** (2.77) -0.430*** (-8.47) Industry 1,362 41.1%

OLS: Log (1+Num_ACov) Rule of Regulatory Law Quality -0.201* -0.346** (-1.82) (-2.39) -0.105 -0.034 (-1.02) (-0.50) 0.105 0.001 (1.00) (0.02) -0.046 -0.053 (-0.65) (-0.73) -0.071*** -0.070*** (-5.52) (-5.29) 0.005* 0.005** (1.85) (1.98) 0.061 0.043 (0.27) (0.20) 0.045 0.043 (0.63) (0.58) 0.113*** 0.111*** (3.26) (3.17) -0.019 -0.015 (-0.94) (-0.69) -0.110*** -0.100** (-2.60) (-2.41) -0.019 -0.036 (-0.33) (-0.58) 0.447*** 0.456*** (6.37) (6.48) 0.103** 0.100* (1.96) (1.88) -0.277*** -0.271*** (-6.15) (-5.89) 0.009 0.010 (1.27) (1.38) 0.031** 0.032** (2.23) (2.31) -0.100*** -0.101*** (-5.70) (-5.81) Industry 1,362 45.1% Industry 1,362 45.2%

Fixed effects N Pseudo/Adjusted R

41.1%

78

Table 13: Hand-collected covenant data sample

This table reports Probit results for D_ACov using hand-collected data replacing the machine-readable data wherever appropriate. In columns titled Diff-in-diff, observations from both treatment and control samples are used. In the column titled All/ Income Statement/ Balance Sheet, D_ACov/D_ACov_IS/D_ACov_BS is the dependent variable. In columns titled Index, only observations from the treatment sample are used. Bae Acct Index and FV Index are measures of distance between prior domestic standards and IFRS. See Tables 4 and 5 for definitions on other variables. The table reports regression coefficients and t-statistics (in parentheses) based on standard errors clustered by firm and year. All continuous variables are winsorized at the 1st and 99th percentiles. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively.

79

Table 13 (contd)
Probit: D_ACov Diff-in-diff Income Statement 0.032 (0.18) 0.485*** (3.02) -1.055*** (-7.19) -0.191 (-0.57) -0.193*** (-7.04) 0.027*** (5.24) 1.308* (1.91) -0.322 (-1.38) 0.073 (0.78) 0.092* (1.83) -0.888*** (-6.05) 0.753*** (4.19) 0.867*** (5.11) -0.020 (-0.12) -0.897*** (-4.26) 0.015 (0.79) 0.169*** (3.17) -0.610*** (-8.71) Industry 3,037 43.7% Index (IFRS countries only) Balance Sheet 0.026 (0.23) 0.022 (0.14) -0.270** (-2.02) 0.140 (0.36) -0.147*** (-4.99) 0.015** (2.08) 1.349** (2.36) 0.275 (0.91) 0.196 (1.46) 0.115** (2.05) -1.274*** (-7.70) 0.767*** (3.55) 0.343* (1.96) -0.116 (-0.90) -0.156 (-1.23) 0.007 (0.46) 0.023 (0.58) -0.003 (-0.07) Industry 3,037 31.6% Bae Acct Post Index PostIndex Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Debt Size Log(Maturity) -0.178 (-0.72) 1.003 (1.54) -1.103*** (-3.67) 0.425 (0.92) -0.216*** (-3.71) 0.005 (0.69) 1.471* (1.72) -0.074 (-0.24) 0.510*** (3.09) 0.112 (1.28) -0.272 (-1.19) -0.495 (-1.13) 0.720** (2.54) 0.096 (0.49) -0.535*** (-3.75) 0.051** (2.10) 0.178*** (3.12) -0.234*** (-3.53) Industry 1,362 30.7% FV -0.257 (-1.25) 0.488 (1.10) -0.960*** (-4.13) 0.437 (0.92) -0.218*** (-3.75) 0.004 (0.53) 1.554* (1.82) -0.045 (-0.14) 0.493*** (3.11) 0.080 (1.04) -0.308 (-1.44) -0.283 (-0.97) 0.712** (2.43) 0.105 (0.53) -0.530*** (-3.69) 0.050** (2.08) 0.176*** (3.07) -0.238*** (-3.74) Industry 1,362 30.6%

All Post IFRS PostIFRS Leverage Size MTB ROA Tangibility USFiling Cred Rghts PrivDebt Mkt Civil Law D_Secured D_Rating InvestGrade Yield Spread Log(Debt Size) Log(Maturity) -0.067 (-0.46) 0.323** (2.11) -0.566*** (-4.06) 0.211 (0.72) -0.224*** (-6.85) 0.023*** (4.22) 2.637*** (3.93) -0.314 (-1.19) 0.296** (2.54) 0.076 (1.44) -1.209*** (-9.30) 0.616*** (3.34) 1.086*** (4.11) 0.147 (0.90) -0.585*** (-4.15) 0.016 (1.34) 0.141*** (3.27) -0.239*** (-4.14) Industry 3,037
2

Fixed effects N Pseudo R

Fixed effects N Pseudo R2

38.0%

80

Figure 1: Histogram of IFRS publications

This figure plots the histogram of new statements and amendment to existing statements issued by IFRS between 1997 and 2012. Changes to multiple accounting standards from the issuance of a new standard or amendment of a standard are counted as a single change.

30 25 20 15 10 5 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Bypublicationyear Byeffectiveyear

81

Figure 2: Accounting covenant use over time

In Panel A (B), the line labelled IFRS countries plots the mean value of D_ACov (Num_ACov) for the treatment sample, i.e. debt issued by firms domiciled in countries that mandated IFRS adoption in 2005. The line labelled Non-IFRS countries plots the mean value of D_ACov (Num_ACov) for the control sample, i.e. debt issued by firms domiciled in countries outside the U.S. that did not have major change in accounting regime during the sample period. D_ACov is a dummy variable indicating that the debt contract contains at least one accounting-based covenant. Num_ACov is the total number of accounting covenants contained in a debt contract. The vertical line IFRS adoption indicates the date when IFRS was mandated in the treatment sample (December 2005). The line Financial Crisis indicates the date when the recent financial crisis started (July 2007).

Panel A: Average accounting covenant frequency

Accounting Covenant Frequency

0.800 0.700 0.600 0.500 0.400 0.300 0.200 0.100 0.000 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 IFRScountries NonIFRScountries

Financial Crisis IFRS adoption

Panel B: Average accounting covenant intensity

Accounting Covenant Intensity

2.000 1.800 1.600 1.400 1.200 1.000 0.800 0.600 0.400 0.200 0.000 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 IFRScountries NonIFRScountries

Financial Crisis IFRS adoption

82