Earnings management and debt∗

Like others before, we find that in our sample of Belgian non-listed firms earnings management (EM) is positively related to leverage. In light of the virtual absence of debt covenants, this regressor cannot just act as a proxy for the risk of violating restrictive covenants in loan or bond contracts (the stock explanation in the US/UK literature); rather, leverage must be proxying for general costs of financial distress. Our main empirical finding is that debt is heterogeneous in this respect: judging by the amount of EM it triggers, in our sample bank debt seems to be perceived as more alarming than trade credit. There are two implications about the relative costs and benefits of bank debt. First, rent extraction by banks is not of the order of magnitude to make the banker as lenient as a regular supplier, in case of financial stress. Second, the quality signal the firm obtains via the bank loan does not make EM redundant; in fact, the signal even fails to reduce the need for EM to the level judged necessary in the case of trad