Illegality in Consumer Debt Contracts and What to Do About it

SYNOPSIS Proposed changes by the FASB and the IASB to lease accounting standards will substantially change the accounting for operating leases by requiring the capitalization of future lease payments. We consider the impact of these changes on firms' debt covenants by examining the frequency of income-statement- versus balance-sheet-based accounting ratios in debt covenants of firms in high and low Off Balance Sheet (OBS) lease industries. Based on debt contracts from the 1996–2009 period, our results provide evidence that lenders focus on balance sheet (income statement) ratios in designing debt covenants for borrowers in low (high) OBS lease industries. Further, the use of balance-sheet- (income-statement-) based covenants falls (rises) faster in high OBS lease industries than in low OBS lease industries as the use of OBS leasing increases. This evidence indicates that OBS operating leases influence lenders' use of accounting information in covenants, suggesting that creditors consider the impact of OBS leases when structuring debt agreements. These results also suggest that the proposed capitalization of OBS leases may not result in firms violating loan covenants but will make the balance sheet a more complete source of information for debt contracting by removing the need for constructive capitalization of OBS leases.

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Consumer Debt and Inflation

Review of Social Economy ◽

10.1080/00346765800000008 ◽

1958 ◽

Vol 16 (1) ◽

pp. 61-64

Author(s):

Paul A. Montavon

Keyword(s):

Consumer Debt

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Asset Specificity and the Secondary Market for Productive Assets

Italian Economic Journal ◽

10.1007/s40797-020-00136-x ◽

2020 ◽

Author(s):

Simone Boccaletti

Keyword(s):

Theoretical Model ◽

Financial Distress ◽

Financial Constraints ◽

Secondary Market ◽

Asset Specificity ◽

Cost Of Debt ◽

Debt Contracts ◽

Trade Off ◽

Distressed Firms ◽

Productive Assets

AbstractThe aim of this paper is to explore how debt contracts are affected by investment in asset specialization and by the dynamics of the secondary market for collateralized productive assets. Before applying for a loan, financially constrained firms face a specificity trade-off: asset specialization increases firms’ project returns, but decreases the liquidation value of assets in the secondary market if the firm is in financial distress. To study this trade-off, the paper uses a theoretical model in which the choice of asset specificity and the outcome of the secondary market for distressed firms’ assets are endogenous. High redeployability costs and a small number of participants in the secondary market are associated to low recovery values and to a high cost of debt. The paper shows the conditions under which financial constraints reduce firms’ incentive to invest in asset specificity.

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