Hedge commitments and agency costs of debt: evidence from interest rate protection covenants and accounting conservatism
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We provide large sample evidence that credible hedge commitments reduce the agency costs of debt and that accounting conservatism enhances hedge commitments. We examine 2,338 bank loans entered into by 263 mandatory derivative users that are contractually obligated by interest rate protection covenants, 709 voluntary derivative users, and 1,366 non-users. We show that loan contracts are more likely to include interest rate protection covenants when borrowers are less likely to maintain the hedge position once the financing is completed. We find that borrowers who credibly commit to hedge using these covenants significantly reduce their interest rates. While we do not find an average interest savings for voluntary derivative users, we do find a reduction in their loan rates when they practice conservative financial reporting. Our results suggest that accounting conservatism helps borrowers resolve shareholder-creditor conflicts by committing to maintain their hedge positions after completing debt financing.
KeywordsAccounting conservatism Interest rate protection Agency costs of debt Hedge commitments
Beatty thanks Deloitte & Touche, for financial support. We are grateful for helpful comments and suggestions from an anonymous reviewer, Gauri Bhat, Chitru Fernando, Rich Frankel, Scott Richardson (the editor), Florin Vasvari (the discussant), the workshop participants at Boston College, The Ohio State University, the University of California at Irvine, McGill University, Massachusetts Institute of Technology, Southern Methodist University, University of Illinois at Chicago, Washington University at St. Louis, and the participants at the 2009 Midwest Accounting Research Conference, the 2009 American Accounting Association annual conference, and the 2011 Review of Accounting Studies annual conference.
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