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Positive accounting theory and the study of corporate control: the role of loan covenants and the going concern qualification

Citron, D.B. (1995). Positive accounting theory and the study of corporate control: the role of loan covenants and the going concern qualification. (Unpublished Doctoral thesis, City University London)


This thesis comprises four published papers (the Papers) - three on accounting-based loan covenants and one on the going concern qualification (GCQ) - plus a linking essay. The essay focuses on the Papers' common subject matter of corporate control and on their common research methodology, positive accounting theory. The essay shows how the agency literature is closely bound up with problems of corporate control. It goes on to argue that certain features of positive accounting theory - its recognition of conflict and of institutional influences, and its focus on economic incentives - render it a particularly useful framework for research into loan covenants and the GCQ. The loan covenant papers address both the structuring of loan agreements ('ex ante' issues) and the subsequent functioning of such agreements, in particular breaches of covenant ('ex post' issues). Their chief contribution to the 'ex ante' literature is the first evidence they provide on the extent and incidence of covenants in the UK; their UK/US comparison, drawing on institutional differences to explain why accounting-based covenants in the UK, unlike the US, have a positive association with term but no association with gearing; and their analysis of the incidence of accounting-based covenants in convertible and secured debt agreements. The Papers' findings on 'ex post' matters contain early evidence on the costliness of covenant breaches, on the effectiveness of managerial opportunism in avoiding covenant violations and on the costliness of mandatory accounting changes. In the context of loan covenants the essay also provides a methodological critique of positive accounting theory, which it sees as a developing research programme. This is reflected both in the ambiguous relation between accounting-based covenants and the investment opportunity set (which is resolved in this research for a UK setting), and in the 'ad hoc' nature of many arguments put forward by the theory's proponents to explain existing practice. Finally, the essay argues that the positive accounting theory and the decision-usefulness views of accounting have more in common than is sometimes supposed. The going concern paper addresses important issues of independence and disclosure. The essay discusses several possible explanations for the low GCQ rate among failed companies, adducing evidence from more recent research. The GCQ paper itself shows that, although the self-fulfilling prophecy argument and differential audit firm size do not appear to prejudice independence, auditor switching may pose such a threat. The essay concludes by pointing at directions for future research, in particular in areas with public policy implications, and by suggesting that greater use of a case study methodology could deepen our understanding of these issues.

Publication Type: Thesis (Doctoral)
Subjects: H Social Sciences > HG Finance
Departments: Bayes Business School
Doctoral Theses
Bayes Business School > Bayes Business School Doctoral Theses
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