Accounting Restatements and Debt Contract Renegotiation

Abstract

This study investigates the impact of accounting restatements on the existing debt contract. Based on a sample of borrowing firms with restatements for the period from 2000 to 2018, we manually construct a novel dataset on debt contract renegotiation. We find that restating firms have a higher likelihood of renegotiation than the firms without restatements. Our examination on how initial contract terms are renegotiated in the post-restatement period shows that, unlike tightening restrictions that new creditors are more likely to react with, creditors in relationship are willing to provide financial flexibility in respond to borrowers' restatements as they are bonded with borrowers' interests, and may perceive the value of long-term customer relationship higher than the potential borrower risk arising from a restatement. Further analysis on restatement severity shows that existing creditors are less likely to relax the original loan terms, if the restatements involve fraud or revenue recognition issues, suggesting that creditors are willing to provide support to debtors only to the extent that the benefits are bilateral. Our findings suggest that renegotiation is a trade-off between bonding interests in existing contracts and creditors' protection against debtors' risk associated with restatements. To our knowledge, this paper is the first to examine the implications of accounting restatements on the renegotiation of existing debt contracts.