Grace Lee looks at debt structure and “conditional conservatism"

Assistant Professor Hye Seung (Grace) Lee’s co-authored paper, “Debt Structure and Conditional Conservatism," was published in 2019 in the Journal of Financial Reporting. The authors investigate whether characteristics of firm debt structure, beyond leverage and debt covenants, are associated with predictable variation in “conditional conservatism.” The contracting theory of conservatism holds that conditional conservatism is an efficient mechanism for the firm to address agency conflict arising from contracts with various parties. For firms with contracts that are associated with more agency conflict, the potential benefit of a conservative reporting strategy should increase. They examine the following debt contract characteristics: (1) convertibility, (2) securitization, (3) seniority, and (4) placement. They find that debt types thought to be associated with a downward shift in agency conflict (convertible, secured, senior, and private debt) are associated with less conservative reporting. Their evidence supports contracting theory as being descriptive of the link between debt and conservatism. Also, their evidence corroborates the assertion that debt contract modifications do not fully resolve lender demands for conservative reporting.