The Role of Accounting Information in Optimal Debt Contracts with Informed Lenders
Darrough, Masako N., Deng, Mingcherng
The Accounting Review · 2019 · Volume 94 · Issue 6
Abstract
We analyze the role of accounting information in debt contracting when the lender has private information that can assist in the borrower's investment decision. The lender might have acquired private information during the due diligence process or via past lending relationships. We show that the borrower has a stronger incentive to engage in a suboptimal investment decision (i.e., asset substitution)ex postwhen the lender lacks incentive to truthfully reveal this information. We identify conditions under which,ex ante,the borrower can incorporate accounting signals in the debt contract to mitigate the effect of the lender's private information and improve the borrower's investment efficiency. Our analysis offers an alternative explanation for the use of performance pricing in debt contracts. JEL Classifications:G21; G32; M41; M48.
Keywords
information asymmetry, asset substitution, accounting information precision, debt contracting
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