Abstract
Using 86 accounting policy changes made by Nikkei-225 Japanese firms, this study examines the correlation between the probability of making accounting policy changes and debt. After controlling other motives for accounting policy changes, we find that a high amount of debt is negatively correlated with the probability of making accounting policy changes, which contradicts the debt-covenant hypothesis. This result suggests that Japanese firms with large amounts of debt do not need to make accounting policy changes to avoid debt-covenant violations because banks within their groups play significant roles in controlling and monitoring their operations. Our findings are consistent with the argument by Inoue and Thomas (1996) – factors that affect the choice of accounting policy in the US may not similarly affect the choice of accounting policy in Japan. We find that the current return on equity and prior year’s return on assets to be negative determinants of the accounting policy changes, and current return on assets and prior year’s change in return on equity are positive determinants. Finally, we find that firms that make accounting policy changes tend to be the ones receiving qualified audit opinions.
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