THE EFFECT OF DEBT CHARACTERISTICS ON THE RECOGNITION OF IMPAIRMENT LOSSES

Abstract

This paper investigates the role played by debt regarding impairment practices of Brazilian publicly traded firms when there are market expectations for the booking of impairment losses, motivated by the premise that debt contracting is the most important source of demand for impairment rules. Our sample of Brazilian publicly traded firms includes 206 unique firms and 7 calendar years, resulting in 1010 firm-year observations. Within this setting, 98 out of 206 firms are in persistently low market-to-book states in at least one period during our sample years. Despite that, there are only 51 firm year observations, regarding only 21 unique firms, in which an impairment loss was recorded. We test debt related hypothesis analyzing the statistical relation between the level of unrecognized economic losses and four debt related variables, the debt to equity ratio, the ratio of short-term debt to total debt, the presence of bonds in the companies’ liabilities and the level of debt financing in the year t. We report evidence that there is an inverted u-shaped relationship between leverage and the level of unrecognized losses. This result suggests that accounting conservatism decreases once the firm secures debt funding but increases for more indebted firms. Short term debt is positively associated to the level of unrecognized impairment losses, indicating that the constant monitoring managers are subject to when they have to frequently renegotiate debt substitutes for accounting conservatism.