2367. Accounting Conservatism and the Efficiency of Debt Contracts: A Real Option Approach
Invited abstract in session TD-6: Financial Reporting, stream Financial Management and Accounting.
Thursday, 14:30-16:00Room: H9
Authors (first author is the speaker)
| 1. | Stefan Kupfer
|
| Lancaster University Management School |
Abstract
In this paper, I examine how accounting conservatism influences the efficiency of debt contracting from a dynamic perspective. Using a real options framework, I analyze how imprecise accounting information affects the timing of financial decisions and the total social loss resulting from management error. Debt contracts rely on such imperfect accounting signals, which can lead to errors in decision-making due to false alarms (inefficient early liquidations) or undue optimism (unjustified prolonged operation). Conservatism increases the likelihood of early loss recognition (false alarms) but reduces the risk of overstated performance. As a result, it affects the timing of actions triggered by accounting signals, potentially leading to liquidation of viable firms or the continuation of unprofitable ones. While prior literature provides theoretical arguments for both liberal and conservative accounting in maximizing welfare, it predominantly relies adopts static frameworks. I contribute by introducing a dynamic perspective. This approach yields novel insights as relatively late or early actions do influence the time value of the welfare effect discussed in the literature. Focusing on the tension between debt and equity holders, I derive the optimal liquidation timing and capital structures under varying levels of conservatism and characterize the resulting welfare effects.
Keywords
- Accounting
- Financial Modelling
Status: accepted
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