Debt Maturity Structure and Accrual Quality

Abstract

Lending short term to firms has been suggested as a means of enhancing monitoring diligence by lenders and, as a result, firm behavior may potentially be improved. However, we show that the presence of short-term debt in firms' capital structures may also entice a very specific form of managerial misbehavior. We examine the relation between firms' debt maturity structures and accrual quality (as an indicator of the propensity to manage earnings). Our results indicate that (i) firms with more current debt have lower quality accruals and may therefore have engaged in earnings management, (ii) the negative relation between short-term debt and accrual quality exists for firms that face debt market constraints and/or those that are riskier (iii) auditor characteristics such as better auditor quality and longer tenure help diminish this relation, and iv) some corporate governance characteristics such as institutional ownership or shareholder protection (measured with the Gompers, Ishi, and Metrick index) have a minor impact on the relation between short-term debt and accrual quality. Our conclusion is that managers of firms with substantial amounts of short-term debt may engage in earnings management to make themselves appear more attractive to lenders and thereby avoid a possible liquidity crisis that may arise when they try to obtain new debt financing or renew existing debt financing.