Accounting Forum 41 (2017) 147–160

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Accounting Forum
journal homepage: www.elsevier.com/locate/accfor

Structural changes in covenants through the adoption of IFRS in MARK

Brazil
⁎
Aziz Xavier Beirutha, , Luiz Paulo Lopes Fáverob, Fernando Dal Ri Murciab,
José Elias Feres de Almeidac, Talles Brugnib
a
Fucape Business School, Brazil
b
Universidade de São Paulo, Brazil
c
Universidade Federal do Espirito Santo, Brazil

AR TI CLE I NF O AB S T R A CT

Keywords: This study examines changes in the structure of covenants in debt agreements of companies
Finance issuing debentures during the adoption of International Financial Reporting Standards (IFRS) in
Covenants Brazil. We investigate debt contracts of public and private companies that issued debentures
Credit Market before and after IFRS adoption in Brazil, between the years 2006–2008 and 2011–2014. We
IFRS
develop a database with all covenants from 126 contracts via hand-collected data, with 78
contracts from before IFRS adoption and 48 contracts afterward. We find high increases in
covenants after adoption. However, this growth is observed only for restrictive security and non-
accounting covenants, excluding clauses with accounting multiples. Our results show that IFRS
adoption in Brazil shifted incentives and, as a result, shaped a new structure of debt contracts.
Our findings complement and expand previous studies and can be useful to academics, regulators
and practitioners by showing that the incentives to use accounting figures and ratios shifted in
the credit market after IFRS adoption.

1. Introduction

We examine the effect of International Financial Reporting Standards (IFRS) on a set of covenants structured in debenture
contracts of Brazilian public and private companies by studying changes in debt contracts near the time of mandatory adoption of
IFRS.
The function of accounting figures and ratios in debt contract arrangements changes over time. One argument is that borrowers
prefer to pay higher interest rates to maintain flexibility through accounting systems to avoid covenant violations (Beatty,
Ramesh & Weber, 2002). Another is that accounting standard changes can affect lenders’ decisions to use covenants based on ac-
counting figures (Demerjian, 2011).
Prior research shows that debt agreements establishes covenants (Smith & Warner, 1979), and IFRS adoption has changed this
relation (Ball, Li, & Shivakumar, 2015). The consequences are reduced information asymmetry as well as potential conflicts of in-
terest. This study expand previous literature (Ball et al., 2015; Brüggemann, Hitz, & Sellhorn, 2013) and contributes to the under-
standing on how IFRS adoption in Brazil as an exogenous shock altered incentives in covenant development.
We posit that restrictive covenants are shaped by incentives in local accounting standards (BR-GAAP) that are strongly oriented to

⁎
Corresponding author.
E-mail addresses: aziz@fucape.br (A.X. Beiruth), lpfavero@usp.br (L.P.L. Fávero), murcia@usp.br (F. Dal Ri Murcia),
feresdealmeira@gmail.com (J.E.F. de Almeida), tallesbrugni@usp.br (T. Brugni).

http://dx.doi.org/10.1016/j.accfor.2017.06.004
Received 29 February 2016; Received in revised form 13 March 2017; Accepted 21 June 2017
Available online 13 July 2017
0155-9982/ © 2017 Elsevier Ltd. All rights reserved.
A.X. Beiruth et al. Accounting Forum 41 (2017) 147–160

rules and based on historical costs of international accounting principles. Moreover, in this new information environment, market
participants should exercise much more judgment regarding accounting figures and consequently the ratios established in debt
covenants.
Debt covenants are defined as provisions to limit accounting and financial decisions (e.g., Smith & Warner, 1979; Leland, 1994).
Covenants are vulnerable to manipulation of financial statements so that the borrower appears to comply with pre-established
accounting standards. A study by DeFond and Jiambalvo (1994) shows that the restrictions imposed by covenants affect accounting
choices in the years before and during which the covenants are violated. However, the shift from local accounting standards to IFRS
also changes incentives, which can impact contract structures.
In many local GAAPs the use of measurement basis is different from IFRS that uses fair value accounting, with different properties
that can reduce the efficacy of the balance sheet information in debt contracts (Ball et al., 2015). Adoption of fair value can be
considered a negative factor for the creditors, given their judgment bias, which leverages the company management’s decisions in
ways that are adverse to creditors. The authors find that the structure of debt contracts has changed due to changes in the financial
indicators established in contracts, aspects of firms’ liquidity and indebtedness and modifications of asset, liability and equity values.
Brüggemann et al. (2013) highlight the importance of studying covenants after the adoption of IFRS since the changes caused by
the adoption of international standards should cause corrective adjustments, modifications in the frequency of certain clauses and
possible renegotiation of contracts.
Brazil is a code law country with low enforcement (e.g., Almeida & Dalmácio, 2015; Lopes & Walker, 2008). As a result, it is
reasonable to expect that debt agreements are well written to avoid court conflicts. However, IFRS adoption in Brazil was divided into
two periods, the transition period in 2008–2009 and the full adoption period in 2010. These two shocks may have affected covenants
before full adoption in 2010.
This paper adds to the prior literature by examining the effect of IFRS adoption on covenants in the Brazilian debt market. Ball
(2006) argues that implementation of IFRS can benefit market participants by reducing information asymmetry among them.
However, IFRS for debt contracts has generated doubts among credit market participants.
Our research design differs from those of previous studies of IFRS adoption in Brazil. We use empirical correspondence analysis to
test our hypotheses and show our results. We develop a unique hand-collected sample from 126 debenture indentures available from
the CVM1 website, for a total of 78 and 48 observations before and after the IFRS adoption periods, respectively. We examine changes
in covenant structure to classify them in accordance with Ramsay and Sidhu (1998) as follows: i) covenants based on security, ii)
covenants based on financial data; and iii) covenants based on non-financial data. Our database includes all types of debenture
contracts. However, the available data do not contain convertible bond contracts. We believe that Brazil’s stock market volatility
explain this characteristic.
Our main finding is a decrease in the use of covenants based on financial data in addition to an increase in the number of
covenants in debt agreements. We also find that contracts have more security covenants. Our results have practical implications for
practitioners and debtors when designing covenants, by showing a shift in covenant quantity and structure from the pre- to the post-
IFRS adoption periods, marked by an increase in the number of security and non-financial data covenants but not the number of
covenants based on financial data.

2. Background literature and hypotheses development

The importance of the relationship between covenants and financial contracts is based on the attempt to avoid nonpayment of
debts or even bankruptcy, causing losses to creditors, which can hinder financial transactions. Smith and Warner (1979) note that
covenants are inserted into loan agreements with the purpose of mitigating conflicts in donor-shareholder relationships, reducing the
financial costs of the transaction and increasing the total amount lent.
The study of covenants in accounting has gained relevance because these clauses are present in most contracts through financial
ratios. This assertion is highlighted in Watts and Zimmerman (1986), who show a strong relation between the covenants and financial
information because covenants are frequently written in terms of accounting figures.
The relations that Watts and Zimmerman (1986) note between covenants and financial information are strengthened by the
subdivision created by Mather and Peirson (2006), who state that the covenants can be divided into two main groups: 1) accounting
and 2) non-accounting covenants. This subdivision, they suggest, shows that financial statements are highly relevant to future control
when financial institutions and other creditors make decisions about providing resources to companies.
Roberts and Sufi (2009) indicate that 96% of private debt issues contain at least one financial/accounting covenant, among which
the most common are covenants that aim to protect creditors against the risk of excess financial leverage of borrowers.
We use the covenant classification method employed by Ramsay and Sidhu (1998), which was based on the classification method
previously proposed by Smith and Warner (1979) and Whittred and Zimmer (1986). Using this classification, we can separate
covenants by their intention of company actuation or restriction. Thus, it is possible to capture the movements made by contractual
parties to guarantee their debt payment.
Ramsay and Sidhu (1998) classify the covenants in debt contracts in the following categories, which we use here:

- Security covenants – restrictive clauses that mandate accelerated maturity in situations that cause uncertainty about the future

1
Comissão de Valores Mobiliários (CVM), equivalent to the US Securities and Exchange Commission (SEC).

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a) Security covenants c) Covenants based on non-financial data

C ross-guarantee R estri cti ons on company’ s i nvestment pol i cy and produc ti on

F i x ed and f l oati ng guarantees R estri cti ons on di vi dend payment and other di stri buti ons
M ortgages R estri cti ons on f undi ng pol i cy
Modification of interest rate in debt contracts
b) Covenants based on financial data Specification of funding activities by the company
Restrictions on control and property
T otal debt S tructure and transacti ons i n corporate groups
Contracting of new debts
Debt insured through mortgage or pledge of assets
Interest coverage preferred right for future funding
Settlement index
Others

Fig. 1. Subcategories of covenants.

solvency of the debtor. Examples of security clauses present in the contracts analyzed are as follows:
- Intervention, settlement or declaration of the Issuer’s bankruptcy.
- Practice by the issuer of any acts conflicting with its bylaws, as well as acts that can directly or indirectly compromise punctual
and full compliance with obligations assumed in the indenture.
- Noncompliance by the issuer with any non-monetary obligations established in the indenture, not cured within XX days.
- Covenants based on financial data – clauses based on financial figures or ratios. Examples of these clauses in the contracts
analyzed are as follows:
- Net Debt/EBITDA ≤ XX.
- Coverage Index of Debt Service (CIDS) ≥ XX.
- EBITDA/Financial Expenses ≥ XX.
- Covenants based on non-financial data – restrictive clauses that intend to control the company’s non-financial aspects. Examples
of the most frequent clauses of this type in the contracts analyzed are as follows:
- Mergers, acquisitions or other forms of corporate restructuring the issuer, any of its (directly or indirectly) controlled companies
and/or its (direct or indirect) controllers.
- Change in the issuer’s stated business purposes.
- Distribution of dividends and/or payment of interest on equity by the issuer if it fails to pay the obligations in the indenture.

The subcategories based on the classification by Ramsay and Sidhu (1998) are displayed in Fig. 1:
Zhang and Zhou (2015) cite recent empirical studies of the loan contracts and reveal that covenants strengthen the rights of
creditors and significantly affect companies’ investments (Chava & Roberts, 2008; Demiroglu & James, 2010; Nini et al., 2009), ca-
pital structure (Nini et al., 2012; Roberts & Sufi, 2009), as well as operating efficiency and stock price performance (Nini et al., 2012).
Shan, Tang, and Winton, (2014) highlight a key point when they observe that although the violation of a restrictive clause
represents default of the debt agreement, it does not automatically trigger a bankruptcy filing. Instead, renegotiation generally takes
place between the creditor and debtor to avoid the need to file for bankruptcy. Thus, the authors suggest that optimized covenants
should focus on the tradeoff between the need to prevent exploitative behaviors against the potential renegotiation costs. One might
say that creditors use covenants as a means of protection to reduce existing conflicts and thus guarantee a larger number of trans-
actions in the financial market. Nevertheless, the study also notes that restrictive clauses require a cost for these transactions.
Among the most used accounting covenants, earlier studies, such as Cotter (1998), Ramsay and Sidhu (1998) and Mather and
Peirson (2006), highlight covenants based on the indebtedness level, interest rate, liquidity index and timely debt payments.
Demerjian (2014) examines the relation between uncertainty and financial covenants in debt contracts, hypothesizing that fi-
nancial covenants are used to limit the effects of uncertainty. The uncertainty of being repaid can be considered the main reason for
financial covenants, by limiting the borrower’s actions based on accounting figures, something that can be monitored quickly to
detect possible risks of default. The author notes that the mean number of financial covenants is 2.5 per contract and that only a small
percentage of contracts contain more than four financial covenants. The findings of Demerjian (2014) show that financial covenants
are but a part of all covenants that companies use in funding contracts.
Literature has extensively examined determinants of debt covenants, but no previous study examined the changing in covenants
through IFRS adoption. Furthermore, since some ratios used in financial covenants is related to working capital then IFRS can affect
the composition of these accounts in financial statements.
Begley and Feltham (1999) note that companies often raise capital by issuing debt and that debt contracts usually include clauses
that restrict business transactions. These covenants are of interest to accounting researchers because many of the covenants are
expressed in terms of accounting figures or items in financial statements, as highlighted in Watts and Zimmerman (1986).
Restrictions on transactions, as cited by Begley and Feltham (1999), as well as other consequences derived from covenants, may
occur due to the implementation of IFRS. However, transactions should not be restricted due to accounting changes that occurred in
the period of transition to IFRS.

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Demerjian (2011) shows recent drop in the use of covenants based on balance sheet data. This trend can be explained, according
to him, by the change in accounting standards, which has made the balance sheet less useful in terms of debt agreements. This trend
conflicts with the principles cited in the adoption of IFRS, which sought to enhance the usefulness of financial statements.
IFRS were developed to serve as a single set of accounting standards adopted across the board by companies worldwide. Pacter
(2003) lists some benefits of a single set of accounting standards at the international level:

1. Easier access to the capital markets of other countries;

2. More credibility of the domestic market to investors from other countries;
3. Lower cost of capital for companies;
4. Better comparability and transparency of financial information among countries;
5. Patterns less subject to domestic political pressures.

The purpose of adopting the new accounting standards was to transform the previous accounting standards to meet the growing
expectations of financial information users (e.g., analysts, investors, financial institutions and creditors).
Regarding the advantages of implementing IFRS in the global context, Ball (2006) suggests the following:

i) iIFRS are more easily understood and stricter than most local Generally Accepted Accounting Principles (GAAP). Thus, there is
greater security for investors regarding the reliability of information.
ii) Small investors are less dependent on professional analysts, given that the information is easier to read, so there is less asymmetry
of information between analysts and investors.
iii) With the implementation of international standards, comparability among companies from different countries is facilitated,
lowering information processing costs.

As one can see, there are many differences between the prior BR GAAP and IFRS (Table 1). In addition to all these differences,
another important feature of Brazilian accounting was the influence of tax legislation. In almost all important matters, tax rules had a
direct influence on the numbers reported by companies. In this sense, before the adoption of IFRS, much of the content of financial
statements in the Brazilian market was not prepared to inform users but rather to meet tax requirements. Furthermore, because
companies wanted to reduce the amount of income tax, accounting policies and numbers were very conservative. In this scenario, the
economic rationale was to record as much expense as possible and consequently to defer revenues to reduce taxable income. This old
environment was favorable to control impacts on financial ratios used in debt contracts.
We argue that the IFRS adoption in Brazil is somehow similar to that in Europe. The fair value concept in accounting is an

Table 1
Treatment under BR GAAP – Before IFRS Convergence.

Items Brazilian GAAP (BR GAAP) – Before IFRS Convergence

Biological assets There was no specific standard addressing biological assets. Some companies treated them at cost and others at net
realizable value, depending on the industry.
Derivatives Derivatives were not recognized on the balance sheet; i.e., they were off–balance-sheet items. Only gains and losses
were recognized in financial statements.
Non-derivative financial instruments There were no specific requirements on accounting for financial instruments. Policies varied among industries.
Leases All leases were considered to be operating leases and treated as off-balance-sheet items. Only lease expense was
recognized in financial statements.
Investment property There were no specific requirements for real estate investments. Most companies treated them as property, plant and
equipment at cost.
Segment reporting Information by segment was not required.
Government incentives All government incentives were recorded as capital reserves in shareholders’ equity, and none were recognized in
income statements.
Cash flow statement Cash flow statements were not required. Some companies voluntarily prepared them. The mandatory statement in
addition to the balance sheet and the income statement was the statement of changes in financial position.
Property, plant and equipment Recognition and measurement were heavily influenced by tax legislation, especially regarding depreciation, where
companies usually adopted the linear method. Overall tax rates depreciated assets faster, so it was not uncommon to
see completely depreciated assets that were still in use by companies.
Research and development costs These costs could be capitalized as deferred charges, which were later amortized in no less than 5 years (tax
legislation) and no more than 10 years (accounting legislation).
Goodwill Goodwill was recognized as a result of business combinations, including, at times those with related parties, and
amortized in no fewer than 5 years and no more than 10 years.
Pre-operating stage expenses All costs were capitalized as deferred charges. The amortization period could be extended over a minimum of 5 years
(tax law) and a maximum of 10 years (corporate law).
Share based payments Stock options provided to employees were not recognized as expenses and were instead treated as transactions
between investors.
Joint ventures Assets and liabilities, revenues and expenses were recognized proportionally to the equity interest of each investor and
consolidated in their respective financial statements using proportional consolidation.
Public concessions The public infrastructure was recognized as property, plant and equipment by the private entities that rendered the
public services.

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innovation in financial reporting that was very conservative (Palea, 2015).

It is important to note that the fair value measurements that came with IFRS, in addition to all the promised benefits of more
relevant information for financial market users, have also been criticized. According to Haslam, Tsitsianis, Hoinaru, Andersson, and
Katechos (2015, p. 12), “In a financialized world the asset values reported by firms on their balance sheets are increasingly de-
temporalized because they embody past, present and future speculation about cash flows and discount rates. Small changes in
assumptions about the future will have a magnified impact on asset values in current time.”
Similar to Biondi (2013), we observed, on the asset side of the balance sheet, a compositional shift from tangible to intangible
assets, including accumulating goodwill, which is the difference between the market and book values of business combinations. Chen,
Chin, Wang, and Yao (2013) argue that the mandatory adoption of IFRS can affect lenders by eliminating certain accounting al-
ternatives, which reduces the possible modifications of accounting information and reduces earnings management opportunities. The
reduction in earnings management opportunities due to IFRS ultimately encourages investors to seek financial credit products.
Lourenço, Branco, and de Almeida Delgado (2015) analyze studies that present empirical evidence that the adoption of IFRS by
companies from countries around the world has a positive effect on the credit market, particularly on the cost and nature of loans and
on the attraction of foreign lenders (Kim, Tsui, & Yi, 2011) and credit ratings (Ling-Ching, Hsu, & Lee, 2013).
Regarding the credit market, Florou, Kosi, and Pope (2012) believe that the mandatory adoption of IFRS has a greater effect on
the relevance of credit in countries with more accounting differences between local standards and IFRS. Overall, the authors’ findings
show increased relevance of accounting credit information based on the application of IFRS in relation to accounting information
based on the application of local rules, and suggest that financial statements after the adoption of IFRS better capture information
affecting companies’ risk of default, which is reflected in their credit rating.
The adoption of IFRS by many countries raises interesting issues in examining covenants based on financial indicators. The
changes in the structure of contracts and errors exposed in pre-IFRS contracts are the subjects of some recent studies.
Ball, Li and Shivakumar (2014) identify a reduction in the use of financial covenants, which were replaced by greater dependence
on non-financial covenants during the transitional period from national GAAP to IFRS, and changes in the use of covenants that are
associated with measures that demonstrate differences between the country’s previous GAAP and IFRS, defined in terms of general
standards and fair value. The authors argue that several aspects of the accounting rules of fair value in IFRS are unfavorable to debt
contracts. The study concludes that fair value accounting (IFRS) incorporates transitory components in the income statement, thereby
reducing the utility of these figures in predicting a borrower's ability to cover future obligations.
Demerjian (2011) finds similar results that indicate a sharp decline in the use of covenants based on financial statements for
private debt contracts, and assumes that changes in accounting standards can explain part of this decline. The decline in the use of
covenants based on accounting numbers may result from the greater possibility of using judgment in the accounting treatment of
assets and liabilities.
Chen et al. (2013) finds results that highlight the increase in interest rates, decreased use of financial covenants based on financial
indicators, and reduction in the average loan maturities. These results occur primarily for borrowers that experienced a greater
increase in income smoothing or increases in abnormal accruals after the mandatory adoption of IFRS.
A consequence highlighted by Ball et al. (2015) is the increased risk for creditors and borrowers caused by the uncertainty that
follows the implementation of IFRS, which can reduce the efficiency of covenants based on accounting figures due to possible impacts
simply because of changes in the accounting treatment. The authors identify a significant reduction in the covenants based on
financial indicators after the mandatory adoption of the IFRS due to the reduced contractual basis of financial information after
introduction of the international standards in income statements as well as covenants that use balance sheet figures. The main
decreases in the use of accounting covenants are observed in countries whose national pre-IFRS standards differed more from IFRS.
Among the factors related to IFRS in the reduced use of financial data to draft contracts, managers’ flexibility to select and apply
accounting standards is highlighted, as well as increased uncertainty in the formulation of rules and greater emphasis on fair value
accounting.
The lesser utility asserted by Ball et al. (2014) and Watts (2006) is in line with expectations after the adoption of international
accounting standards, which is the improved quality of the accounting figures and the increased comparative and explanatory power
for accounting information users.
Christensen, Hail, and Leuz (2009) identify flaws in considering the role of accounting at the time of acquiring debt post-IFRS
because creditors sought to reconcile IFRS with information about the future operating cash flows of a particular company rather than
information about the probability of violating covenants. The findings of Christensen et al. (2009) show that the market still has not
adjusted to IFRS and that there is a need for studies to try to correct the identified flaws.
Houqe, Monem, and Clarkson (2013) note that the effects of the mandatory adoption of IFRS in the debt market will be greater in
countries with strict legal regulations, low financial risk and minimal differences between domestic GAAP and IFRS. These effects are
strong because debt security holders require higher return and impose a larger amount of debt covenants in countries with little
protection of creditor rights.
Brüggemann et al. (2013) state that if the contract balances are interrupted by mandatory adoption of IFRS (consistent with
covenants based on current GAAP) and corrective adjustments are made, then the frequency and design of covenants based on
accounting should change. As a result, for example, renegotiation limits on covenants can be observed.
Overall, IFRS rules seem to sacrifice their relevance to debt contracting to support other goals, such as providing a better ac-
counting model with measurement focused on valuation, as shown in Ball et al. (2014). Thus, understanding the effects of the
adoption of IFRS for the debt market is extremely important given the size of this market and the effects of debt contracting on the
companies’ and creditors’ futures.

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To determine what changes have taken place and what impact these changes have caused in contractual covenants after the
implementation of IFRS standards in Brazil, we analyzed the following research hypotheses:
H1. There is a difference between the proportional structures of covenants in debenture indentures in Brazil before and after the
adoption of IFRS.
H2. Covenants based on financial indicators were proportionately present more often in the pre-IFRS period.

3. Research design

To analyze the changes found in the sets of covenants present in debt contracts after the adoption of IFRS in Brazil, we created a
database composed of corporate debt contracts in the pre- and post-adoption phases of international accounting standards. This
allows comparing covenants and covenant structures most often present in each group and thus provides evidence of changes in the
structure of covenants to help creditors collect on their loans.
The study relies on a sample of companies that issued debt in the period before the adoption of IFRS, which for temporal analysis
purposes comprised the period between 2006 and 2008, as well as companies that raised funds in the period after the adoption of
international accounting standards, in this case the period between 2011 and 2014.
Our design compares the pre-IFRS adoption period (2006–2008) to the post-IFRS adoption period (2011–2014). Importantly, we
excluded the years 2009 and 2010 because IFRS convergence in Brazil was conducted in two phases.
At the end of 2007, the Brazilian Congress approved Law 11,638/07, requiring the progressive convergence of Brazilian GAAP
with IFRS. For this convergence, the Brazilian Accounting Standards Committee (Comitê de Pronunciamentos Contábeis – CPC) issued
15 technical statements to meet the requirements contained in that law by the end of 2008. These technical statements were all based
on IFRS. The great majority are just translations of IFRS into Portuguese. Some contained small adaptations to comply with the basic
corporate law (Law 6404/76).
By that period, partial convergence to IFRS had been achieved because companies had to adopt all 15 technical statements. After
completion of this initial cycle, the CPC issued the remaining technical statements during 2009 and 2010, to achieve full adoption of
IFRS in Brazil. This process ended with the so-called “First Time Adoption of IFRS” by Brazilian public companies, in their con-
solidated year-end financial statements for 2010.
In this sense, because we wanted to capture the effect of pre- and post-IFRS implementation, we excluded the years 2009 and
2010, during which companies were partially adopting IFRS in Brazil. This also made economic sense because this period was marked
by the aftereffects of the subprime financial crises that spread around the globe.

3.1. Data collection

Data collection was one of the most important and difficult stages of the study. The difficulty arose due to the absence of a
database containing all the information needed, which made it necessary to build a new database.
To develop the database, we used the public announcements issued and prospectuses filed regarding debenture issues, which were
extracted from the websites of the Brazilian Securities Commission (CVM) and the National Debenture System, maintained by
ANBIMA, pre- and post-adoption of international accounting standards. Companies’ debenture indentures were manually collected
and limited to one contract per company for the period (before and after adoption). We sought to standardize existing contracts when
the funding occurred in stages, so as not to bias the results.
The construction of the database began with reading and interpreting the restrictive clauses in each indenture. In this stage, we
used the methodological approach of document analysis.
After identifying and reading the covenants, the clauses were classified in accordance with the method proposed by Ramsay and
Sidhu (1998), into the following categories: security covenants, accounting covenants and non-accounting covenants, which will be
explained further in a specific subsection. In this phase, more than 2200 covenants present in the 126 contracts of the sample were
classified through individualized reading of every clause and subsequent classification as described by Ramsay and Sidhu (1998), in
accordance with the focus of the clause. The years 2009 and 2010 are not in the database because the transition period to IFRS
occurred from 2008 to 2010.

3.2. Data analysis

After the classification stage, statistical analysis was conducted to determine what changes occurred in the structure of these
contracts in terms of covenants. Among the models previously selected according to preliminary studies for the compilation of results,
the models of correspondence analysis (ANACOR) and multiple correspondence analysis were used, in addition to the necessary
comparison of means and variance analysis tests.
ANACOR is described by Fávero and Belfiore (2015) as one of the techniques developed to analyze nonlinear relationships and
data with categorical responses, measured in nominal terms. The main objective of ANACOR is the grouping of strongly associated
variables, building a representation of the relationships between the categories of variables on a perceptual map.
According to Fávero, Belfiore, and Fouto (2006), ANACOR:
(…) consists of two basic steps, related to the calculation of the association measure and the creation of the perceptual maps.

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Table 2
Subdivision of the sample.

Total Covenants × IFRS

Total Covenants Before Freq. Before After Freq. After Total

0–5 2 66.7% 1 33.3% 3

6–10 12 70.6% 5 29.4% 17
11–15 24 80.0% 6 20.0% 30
16–20 32 76.2% 10 23.8% 42
21–25 7 36.8% 12 63.2% 19
26–30 1 14.3% 6 85.7% 7
31–35 0 0.0% 5 100.0% 5
36–40 0 0.0% 2 100.0% 2
41–45 0 0.0% 1 100.0% 1

Total 78 48 126

ANACOR uses the χ2 test to standardize the frequencies and constitute the base for the associations. Based on a contingency table, the
expected frequencies and the χ2 coefficient for each cell are calculated, considering the differences between the observed and
expected frequencies. Hence, using the standardized association measures, ANACOR creates a measure in metric distances and
orthogonal projections on which the categories can be allocated, to represent the degree of association, given by the χ2 distances in a
dimensional space (p. 8).
Fávero and Belfiore (2015) note that multiple correspondence analysis allows for the inclusion of qualitative variables and reveals
possible associations in a visual and two-dimensional form. The analysis proposed in the study has not been used previously in studies
of covenants.

4. Results and discussion

4.1. Descriptive statistics

In its final version, the database included 126 Indentures, 78 from the period before the adoption of IFRS and 48 from the post-
IFRS period. Table 2 below shows the subdivision of these data and their frequencies before and after the adoption of IFRS concerning
the number of covenants.
The maximum and minimum values and the means and deviations per covenant category, according to the classification by
Ramsay and Sidhu (1998), are presented in the following table, which reveals a greater contingent of covenants in the contracts after
the implementation of IFRS (Table 3).
The results presented in the above table are similar to those of Demerjian (2014), who notes that a small percentage of contracts
include more than four financial covenants.
It should be noted, however, that the same author finds results in which the mean number of financial covenants per contract is
2.5, higher than that found for our sample. The results found by Demerjian (2014) show that financial covenants are only a portion of
all covenants used in the companies’ funding contracts, which is also compatible with our findings.
The graph below shows the increase in the number of covenants after IFRS adoption (Fig. 2).

4.2. Correspondence analysis and t-test

With the database prepared for statistical processing, the first procedure adopted was to apply the t-test for equality of means and
the equality of variances test to verify the existence of correlation between the variables studied, that is, whether the periods before

Table 3
Descriptive statistics.

Number of Covenants Covenants based on financial data Security covenants Covenants based on non financial data

Before IFRS
Maximum 26 4 19 14
Minimum 4 0 3 0
Mean 15.37 1.64 8.35 5.38
Standard Deviation 4.64 1.14 2.42 2.63

After IFRS
Maximum 42 4 23 20
Minimum 4 0 3 0
Mean 21.46 1.35 11.90 8.21
Standard Deviation 8.71 1.02 4.95 4.15

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Fig. 2. Type of covenants per year.

and after IFRS were correlated with the number of covenants. Thus, four tests were performed for equality of the means and var-
iances.
The first test to verify the correlation of the variables aimed to relate the variables Period (before or after the IFRS) and Type of
Covenants. The first part of Table 4 shows differences in the sample in terms of the number of covenants before and after IFRS
adoption, as well as the existence of different variances between the two periods for the same sample:
The second and third parts of the table aim to relate the variables Period (pre- or post-IFRS), Number of Security Covenants and
Number of Non-Accounting Covenants. We found differences in the means of the samples regarding the number of covenants pre- and
post-IFRS, as well as different variances between the two periods for the same sample. The fourth part of table shows the correlations

Table 4
t-Test and test of equality of variances for all covenant types.

Num. Observations Mean Standard Error Standard Deviation Confidence Interval

Total Covenants
Pre IFRS 78 15.371 0.526 4.643 14.32 16.41
Post IFRS 48 21.458 1.257 8.712 18.9 23.98
Total 126 17.69 0.634 7.115 16.43 18.94
diff = mean(before) − mean(after) t = −5.10 H0: diff = 0 Degrees of Freedom 124
proporção std.dev(before)/std.dev(after) f = 0.284 H0: ratio = 1 Degrees of Freedom 77.47
Ha: ratio < 1 Ha: ratio dif 1 Ha: ratio > 1
Pr(F < f) = 0 2*Pr(F < f) = 0 Pr(F > f) = 1

Security Covenants
Pre IFRS 78 8.346 0.274 2.422 7.8 8.892
Post IFRS 48 11.896 0.715 4.952 10.458 13.333
Total 126 9.698 0.354 3.978 8.997 10.399
diff = mean(before) − mean(after) t = −5,37 H0: diff = 0 Degrees of Freedom 124
proporção std.dev(before)/std.dev(after) f = 0,239 H0: ratio = 1 Degrees of Freedom 77.47
Ha: ratio < 1 Ha: ratio dif 1 Ha: ratio > 1
Pr(F < f) = 0 2*Pr(F < f) = 0 Pr(F > f) = 1

Non-accounting Covenants
Pre IFRS 76 5.526 0.288 2.511 4.953 6.1
Post IFRS 47 8.383 0.585 4.014 7.205 9.561
Total 123 6.618 0.31 3.448 6.002 7.233
diff = mean(before) − mean(after) t = −4,86 H0: diff = 0 Degrees of Freedom 124
proporção std.dev(before)/std.dev(after) f = 0,3914 H0: ratio = 1 Degrees of Freedom 75.46
Ha: ratio < 1 Ha: ratio dif 1 Ha: ratio > 1
Pr(F < f) = 0 2*Pr(F < f) = 0.0003 Pr(F > f) = 0.9999

Accounting Covenants
Pre IFRS 57 2.245 0.084 0.63473 5 2.414
Post IFRS 34 1.911 0.106 0.621 1.695 2.128
Total 91 2.12 0.068 0.646 1.986 2.2
diff = mean(before) − mean(after) t = 2,44 H0: diff = 0 Degrees of Freedom 89
proporção std.dev(before)/std.dev(after) f = 1,044 H0: ratio = 1 Degrees of Freedom 56.33
Ha: ratio < 1 Ha: ratio dif 1 Ha: ratio > 1
Pr(F < f) = 0.544 2*Pr(F < f) = 0.911 Pr(F > f) = 0.456

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Table 5
Correspondence analysis – total covenants per year.

Dimension Eigenvalue Principal Inertia Chi2

1 0.628 0.395 49.750

2 0.431 0.186 23.420
3 0.286 0.082 10.340
4 0.207 0.043 5.410
5 0.070 0.005 0.620
6 0.019 0.000 0.040

Total 0.711 89.580

Num. Observations 126 Prob > chi2 0.0003
Num. Dimensions 2 Explained Inertia (%) 81.68

between the variables and relates the variables Period (pre- or post-IFRS) and Number of Accounting Covenants. No correlation was
found between the variables.
Thus, one can see the correlation between the number of security covenants, non-accounting covenants and total number of
covenants and the periods before and after the adoption of international accounting standards, which indicates changes in the
structure of the restrictive clauses of debt agreements.
The results are in line with studies by Ball et al. (2015), who identify a reduction in the use of accounting covenants, these being
replaced by greater dependence on non-accounting covenants during the transition period from Brazilian GAAP to IFRS. Haslam et al.
(2015) find a significant adjustment in the structure of balance sheets from tangible to intangible assets, reflecting the potential value
of increased risk. This finding can be one of the reasons for the increasing use of non-financial covenants in debt contracts.
After the correlation tests, we performed tests to demonstrate the association between variables. Correspondence analysis
(ANACOR) was applied between the variables number of covenants and year of issuance of the debentures, which showed the
existence of an association between a larger number of covenants and the years following the adoption of international standards
(2011–2014).
ANACOR revealed associations between the variables when the chi-square coefficient was significant. The null hypothesis of the
chi-square statistic states that there is no association between the two variables and, thus, there is randomness in the combination of
the categorical variables. The output of the correspondence analysis shown below (Table 5) indicates that the null hypothesis of the
chi-square statistic is rejected, revealing association between the variables.
The table above also shows the percentage of information explained by the axes of the statistical technique and the percentage
proportion of variance explained by the dimension. In this particular case, we can note two relevant dimensions, inertia being
superior to 15%. The correspondence analysis derived two dimensions for the flat projection of the categories of the variables.
Together, these dimensions represent 81.6% of the variation of the original χ2 distances.
The results can be found numerically by means of tables with statistical outputs, or visually by the perceptual maps generated
through correspondence analysis.

41 - 45

2014 2008
11 - 15 2006
31 - 35
0 -5 2007
6 - 10 16 - 20
2012

2011
21 - 25
26 - 30

2013

36 - 40

Fig. 3. Perceptual map – number of covenants per year.

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Table 6
Correspondence analysis – Security covenants per year.

Dimension Eigenvalue Principal Inertia Chi2

1 0.585 0.342 41.150

2 0.341 0.116 14.670
3 0.279 0.078 9.860
4 0.039 0.001 0.200

Total 0.539 67.870

Num. Observations 126 Prob > chi2 0
Num. Dimensions 2 Explained Inertia (%) 85.19

The perceptual map produced (Fig. 3) graphically shows an association between the years following the adoption of international
standards and a higher total number of covenants (black dots) in the indentures after 2011, which indicates the use of more covenants
after the adoption of the international accounting standards.
Batista, Escuder, and Pereira (2004) report that when categories of the same variable are situated near each other on the cor-
respondence analysis map, this suggests that, regardless of their semantic content, they can be considered equivalent with respect to
the distribution of masses of all observations made.
The map shows the association of the years 2011, 2012 and 2013 with all covenants present in the contracts, corresponding to
21–25, 26–30 and 31–35 in the post IFRS period, respectively, as well as the greater association of the years 2006–2008 with the
subdivisions 0–5, 6–10, 11–15 and 16–20 covenants present per contract, respectively.
Results with the same features are found when performing the correspondence analysis with security covenants and non-ac-
counting covenants pre- and post-IFRS. The statistical results shown in Tables 11 and 12 underscore the association between number
of covenants and the pre- and post-IFRS.
In the correspondence analysis performed between the years and the number of security covenants, based on the chi-square test,
the lack of association between the variables was rejected. The proportion of variance explained by the statistical test is also con-
siderable (Table 6).
The data for the non-accounting covenants are similar to the data shown earlier, rejecting the null hypothesis of no association
between the variables. Nevertheless, the greater predictive power of the inertia in this case should be noted. The correspondence
analysis derived two dimensions for the flat projection of the variable categories. Together, these dimensions were able to represent
85.2% of the variations in the original χ2 distances (Table 7).
The perceptual map produced, as with the total number of covenants, highlights the association between the years after the
adoption of the international standards and a larger number of covenants for the number of security covenants (Fig. 4).
With respect to the years 2006–2008, there clearly exists greater proximity to the number of security covenants between 6 and 10,
and the years 2011 and 2012 are more associated with the number of covenants 11–15.

4.3. Econometric approach

With the objective of confirming our correspondence analysis, we propose an empirical model that includes the number of
covenants, the gross domestic product variation, and the IFRS adoption period, in addition to the control variables:

Number of Covenantsi = α + β1. ΔGDPi + β2. IFRSi + ∑ δj .Controlsi + εi

j

where IFRS a dummy variable related to IFRS adoption period, and △GDP refers to the Brazilian economy, responsible for capturing
possible effects of the financial crisis. The controls refer to industry characteristics.
The results in Table 8 show that IFRS adoption provides incentives to increase the number of covenants in Brazilian debt
agreements, since it has a positive coefficient (2.96*). This empirical result complements the qualitative finding of the correspon-
dence analysis.
The regression model corroborates the correspondence analysis results, showing that IFRS adoption increases the number of

Table 7
–Correspondence analysis − Non-accounting covenants per year.

Dimension Eigenvalue Principal Inertia Chi2

1 0.447 0.199 25.140

2 0.249 0.062 7.800
3 0.175 0.031 3.880

Total 0.292 36.820

Num. Observations 126 Prob > chi2 0.0055
Num. Dimensions 2 Explained Inertia (%) 89.47

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11 - 15 2012

2011

2013
0-5

2008
2006
16 - 20
6 - 10 2007

2014

21 - 25

Fig. 4. Perceptual map – number of security covenants per year.

Table 8
Regression – Number of Covenants.

Number Of Covenants Coef. Std. Err t P > |t|

ΔGDP −73.1 49.35 −1.48 0.141

IFRS 2.96 1.67 1.77 0.08*
Construction Industry 2.58 2.42 1.06 0.29
Eletricity Industry 0.27 2.19 0.9 0.9
Financial Industry −8.19 2.44 −3.35 0.000***
Infra-Sctruture Industry 3.1 2.28 1.36 0.175
Oil and Gas Industry −2.2 3.04 −0.73 0.47
Other Industry −1.26 2.39 −0.53 0.6
Const 19.71 0.002 26.06 0.000***

p-value: *** 1%; **5%; *10%.

F(8,117) = 10.74.
Prob > F = 0.000.
R-squared = 0.4234.

covenants. The IFRS dummy variable parameter is statistically significant (10%) and positive, demonstrating that after the adoption
of IFRS, the number of covenants per contract increased, in the presence of the other variables and ceteris paribus. Additionally, there
is no significant relationship between financial crisis and growth of covenant numbers.
Based on the results, it can be stated that structural changes took place in debt agreements with respect to covenants in the period
of transition to international accounting standards, in which the years following the adoption of those standards produced a larger
number of covenants than the period before their adoption.
The results are relevant concerning the market’s acceptance of IFRS, even during the period of global economic instability, which
occurred during most of the years studied. This statement is based on the strong proportional growth of restrictive security and non-
accounting clauses and stability in the number of accounting covenants; i.e., creditors increased their protection through various
types of clauses, except the accounting type.
Thus, it is not possible to reject the research hypothesis H1, which highlights a difference in the structure of covenants in the
contracts for debentures issued in Brazil before and after the adoption of IFRS.
There were significant increases during the post-IFRS period in the security and non-accounting covenants, according to the
classification of Ramsay and Sidhu (1998), and no increase or decrease was observed in the number of accounting clauses in the same
period.
The non-occurrence of a reduction in absolute terms in the number of covenants based on accounting figures also permits
rejecting the research hypothesis H2, indicating the increased presence of covenants based on financial indicators in the pre-IFRS
period. However, the proportional decrease of accounting covenants should be emphasized, because the other categories of clauses
guaranteed greater participation, proportional to the total number of covenants used in the debenture contracts.
It is noteworthy that the adoption of international accounting standards is not the only occurrence with potential impact on this

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result. Other relevant factors can include the economic crisis experienced during the period and other economic factors affecting
companies. However, it is notable that the resource providers sought further security in funding agreements and that this security did
not come from clauses based on accounting figures.
The results corroborate the claims of Ball et al. (2014) of a significant reduction in the covenants based on financial indicators
following the mandatory adoption of IFRS, due to the reduced contractual base after the adoption of international standards. The
decline in the use of accounting covenants is observed for both covenants that use the income statement and for those using balance
sheet numbers, and the largest decreases in the use of accounting covenants are observed in countries whose pre-IFRS national
standards differed more from IFRS.
The same authors also reported that, compared to the previous national standards, IFRS make greater use of fair value accounting,
which has several properties that can reduce the effectiveness of balance sheet information for debt contracting. Thus, the adoption of
fair value can be considered a negative factor for lenders, in view of its features with a judgment bias, which enhances decisions
adverse to creditors by company management.
The results underscore the claim by Brüggemann et al. (2013) of the importance of studying covenants after the adoption of IFRS.
They also note that the changes caused by the adoption of international standards should lead to corrective adjustments, changes in
the frequency of certain clauses and possible renegotiation of contracts between parties, all of which were found in our survey
responses, with higher frequencies of security and non-accounting covenants.
The findings of Demerjian (2011) are consistent with our results, showing a decrease in the use of covenants based on balance
sheet data, the substrate of financial clauses. This decrease can be explained, according to the author’s hypothesis, by the change in
accounting standards, which made the balance sheet less useful in terms of debt agreements, going against the principles cited in
favor of implementing IFRS, which sought to increase the usefulness of financial statements.

5. Conclusions

The adoption of international accounting standards in the Brazilian context caused the country to change from standard based on
rules and with related to tax accounting to an accounting standard guided by principles requiring judgment by the financial state-
ments preparer and increasing the subjectivity of financial information, which modifies both the financial statements and other
documents that are influenced by these statements.
After using the proposed method and analyzing the results, we noted changes in the debt contracts with the introduction of
international accounting standards in Brazil. Our objective was to show the possible structural changes in covenants with the in-
troduction of IFRS in Brazil.
Starting from the assertion by Watts and Zimmerman (1986) that financial reports can reduce the asymmetry of information
between lenders and borrowers, increased use of financial reporting by the providers of capital was expected, in view of the increased
transparency expected as a result of the international standards.
However, our results are contrary to the expectations based on Watts and Zimmerman (1986), in view of the lesser use of
accounting information in the preparation of covenants. The new accounting scenario, with greater room for judgment, seems to have
affected and even distanced lawyers and financiers, who prepare debt agreements, from the use of accounting information.
As stated by Santos, Fávero, and Distadio (2016), considering the difficulties to assess credit by new investors or creditors, a
stronger trend is observed for governments to adopt policies and institutional improvements that can facilitate companies’ capita-
lization through equity or debt. One of the measures governments have adopted to improve the credit and capital markets is the
adaptation of their countries’ accounting models to generally accepted international standards proposed by the International Ac-
counting Standards Board (IFRS), which are aimed at the harmonization of corporate financial statements in different international
markets, favoring these countries’ inclusion in the movements of external capital, as well as giving investors and creditors’ greater
confidence in companies.
Our results indicate the opposite to the intended by IFRS. Results show greater insecurity on the part of capital providers, with the
increased use of covenants focused on security and a ban on investment, reducing dividend payments, additional guarantees and
other non-accounting covenants. However, the financial covenants lost a proportional share of the contracts.
The findings are in line with studies by Ball et al. (2015), in which the authors suggest that IFRS weaken the usefulness of
accounting information for creditors, given the increased interest in judging criteria for the measurement of accounting figures.
The statement by Ball, Robin, and Sadka (2008) on the importance of attempting to understand the reaction of creditors and debt
agreements in the event of changes in the accounting standards adopted reinforces the importance of the present study’s results,
because, according to the authors, while financial reporting is more influenced by the credit market, the findings show a loss of
influence of accounting figures in debt contracts.
Christensen, Hail, and Leuz (2013) and Daske, Hail, Leuz, and Verdi (2013) identified a significant evolution in the transparency
standards in countries that adhere to international standards, resulting in a greater impact on the capital markets in economies with
characteristics such as greater protection of investors.
Our findings indicate that IFRS reduced the usefulness of accounting information for creditors, i.e., there was a shift from financial
to non-financial information based covenants. In other words, our findings emphasize that security and non-financial covenants were
reinforced after the financial crisis rather than tipping towards financial information based covenants as a result to adopting IFRS in
opposite with Christensen et al. (2013) and Daske et al. (2013).
That contradicts the main objective of financial reporting, stated by the IASB’s Conceptual Framework in paragraph OB2, which is
“to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other

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creditors in making decisions about providing resources to the entity.”

It seems that the increased judging criteria for the measurement of some accounting figures, especially regarding fair value
measurements, as well as the “non-cash” effects brought by these measurements, have reduced the predictability of accounting
information.
Thus, according to our results, the benefits promised by IFRS adoption did not take place in the Brazilian debenture market. This
is because:

(i) IFRS adoption did not directly impact the debenture covenants linked to financial numbers, instead taking predominantly a
security form; and
(ii) After IFRS adoption, non-financial covenants became even more preferred by creditors.

Its possible to say that what matters to bondholders is security through limits on dividend distributions that might compromise
their reserves, as the first hedge against asset value and earnings risks.
In this scenario, we believe our study might be relevant to the IASB as well as other standard setters in evaluating the usefulness of
accounting information for contractual purposes with creditors.
Finally, it is worthwhile mentioning that other factors might have influenced our time series analysis; especially the financial
crisis that took place in 2008, which had a huge impact on the credit market around the globe.
As result of the crisis, the requirements for more non-financial covenants should increase. Thus, we would expect to see more non-
financial covenants in the post financial crisis period. After all, market participants demand more guarantees after a market melt-
down.
In this scenario – of higher security demands for lending money to companies – we also would expect more financial covenants, as
well as covenants being more relevant due to a “better and ‘global’ GAAP. However, according to our results, that did not happen in
Brazil, which raises questions about the benefits of IFRS adoption for the credit market, as outlined above.
These findings shed light on the actual strength of international accounting standards for the Brazilian credit market, because
several studies have shown the great usefulness of this information for the capital markets. Thus, the data complement the research
objective of investigating the structural changes in covenants in debt agreements as a result of the adoption of international ac-
counting standards in Brazil.

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