Implications of Non-equity Financing for Firm Financial Reporting Quality and Information Environment

Prior studies in accounting and finance have extensively evaluated the way a firm interacts with, and subsequently responds to, its contracting agents under various conditions. Specifically, studies have explored the role of accounting information in mitigating agency conflicts and designing efficient contracts. My dissertation consists of three separate, albeit closely related, studies that extend the prior understanding of contracting relationships by documenting financial reporting outcomes of those relationships. First, I investigate whether and how the presence of debt in the capital structure improves a firm’s information environment. Empirical findings show that, after controlling for all known confounding factors, debt is negative associated with information environment. Results using various measures of financial leverage indicate that analysts forecast accuracy (forecast dispersion) is high (low) for firms that use no/low debt. Additional analyses show that the effect of financial leverage is stronger for unrated firms, smaller firms, firms with low analysts following, and firm with low institutional shareholdings. Overall, results suggest that additional information generated by debt does not enhance information environment of a firm, rather firms with no/low leverage have incentives to provide superior information and facilitates market participants to make informed decisions. Second, I decompose leverage into operating and financing, and examine differential effects types of leverage on a firm’s information environment. Results indicate that both operating liability leverage and financing leverage is negatively associated with the information environment of a firm. If I further decompose operating liability leverage into estimated and contractual, the negative association between leverage and information environment persists. Third, I investigate whether restrictive covenants imposed by lenders impact financial reporting quality of a firm. Primary empirical findings indicate that debt covenant strictness in general does not affect financial reporting quality of a firm. However, when separated out, strictness in capital covenant establishes less monitoring and thus reduces firm financial reporting quality. To address endogeneity, I use lender-specific financial shock as an instrumental variable (IV), suggested in Murfin (2012). The instrumental variable approach substantiates the findings