Debt Covenant Violation and Real Earnings Management: Evidence From the U.S.

Purpose: This article examines the real earnings management activities of U.S. firms after their covenant violations. Design/methodology/approach: Regression discontinuity design is adopted to conduct the analysis. Findings: This study shows that, instead of manipulating accruals, the firms make more real earnings management after their financial covenant violations. When covenant violations are classified on net worth and current ratio covenant restrictions, different patterns of real earnings management are detected. Research limitations/implications: This finding enriches the debt covenant hypothesis on whether managers carry out real earnings management after a covenant violation. Practical implications: This paper provides a new perspective for understanding earnings management and is of great significance to alert stakeholders and the monitoring system to the firm’s self-interest behavior and emphasizes the significance of investor protection in the context of covenant violation. Originality/value: The issues investigated in this paper have never been studied in the literature. This study provides a new perspective for understanding earnings management and is of great significance to alert stakeholders and the monitoring system to the firm’s self-interest behavior and emphasizes the significance of investor protection in the context of covenant violation.