The Debt-contracting Value of Accounting Numbers, Renegotiation, and Investment Efficiency

This study investigates the impact of the debt-contracting value (DCV) of borrowers' accounting information on the likelihood of private debt renegotiation and the implication of renegotiation for borrowing firms' investment efficiency. Accounting numbers, as contractible signals, are broadly used in formal debt contracting. DCV captures the inherent ability of firms' accounting numbers to predict future credit quality. Building on incomplete contract theory, I hypothesize that a lower DCV of a borrower's accounting numbers creates ex post incentives for both parties to renegotiate the terms of the initial contract, leading to a higher probability of renegotiation. During the renegotiation, the lenders can extract partial gains from the borrowers' investment according to their relative bargaining power. Anticipating the high-probability of renegotiation reduces the ex ante investment incentives of borrowers, inducing underinvestment. Using a sample of 3,720 private debt contracts, I find that 76% of the contracts are renegotiated before maturity, and 75% of renegotiation cases are related to the changes of accounting-based contractual terms. I further find that firms with a higher DCV have a lower probability of renegotiation and less underinvestment. Moreover, the impact of DCV on investment increases with lenders' relative bargaining power.Ph