Financial Reporting Quality and Debt Contracting in Emerging Economy

Abstract

This study investigates relations between debt contracting and asymmetries in timely recognition of firms' earnings in emerging market economy. The asymmetric timelines of earnings, as a measure that determines predictive power of financial reports, is observed proxy explaining borrowers' earnings management. This study use longitudinal research design to explore asymmetric timeliness of earnings and its association to debt contracting. The study result suggests that the change in asymmetric timelines of earnings is significantly associated with intention of long term debt contracting application that ends with the long term debt contract closure. In more particular, the positive (or negative) change in net income in previous period is associated with the decrease in net income change in consecutive periods for firm-years when no contract is closed. Vice versa, negative net income change in prior period, reported by firm-years prior long term debt application, is associated with an increase of net income change in consecutive period. On the other hand, there is no earnings management detected in years prior to long term debt application for the firms that have reported prior positive change in net income. The research is based on specific data set extracted from financial reports in Bosnia and Herzegovina.