The Determinants of Accounting Choices in Troubled Companies

Abstract

This paper uses a multivariate regression analysis to examine the determinants of accrual accounting choices in i27 troubled firms. Troubled firms are defined as those that experienced three consecutive losses and reduced dividends. Most studies in positive accounting research examine samples of firms that include both healthy and financially distressed firms. These studies assume implicitly that contracting incentives have the same effect on the accounting choices of distressed firms as those of healthy firms and that the marginal cost of managing earnings is the same for both types of firms. This paper, however, focuses on troubled firms alone. The results provided in this paper suggest that firms in financial distress have incentives to adopt income-decreasing accounting choices in the year of a nonroutine top executive change. The results do not support earnings management due to binding debt covenants, union negotiations, or government lobbying, thus suggesting that for troubled firms the pay-offs from these types of earnings management are too low to influence managers '