Earnings Management to Avoid Debt Covenant Violations and Future Performance

Scott D. Dyreng, Stephen A. Hillegeist, Fernando Penalva

Research output: Contribution to journalArticlepeer-review

18 Scopus citations


In this study, we examine the trade-offs between earnings management (both accruals and real) and covenant violations by examining how they are associated with future accounting and stock market performance. We analyze a matched-pair sample of covenant violation firms with non-violation firms that have a similar risk of a covenant violation. We have three main findings. First, our evidence indicates that covenant violations are costly events for shareholders as lenders appear to use their control rights in ways that increase the likelihood of loan repayment but impose costs for shareholders. Second, there is limited evidence indicating covenant-related accrual-earnings management activities impose significant costs on shareholders, but we find shareholders are worse off following unsuccessful real earnings management. Third, our evidence indicates that, on average, shareholders at high violation risk firms are better off when their firms successfully engage in accruals earnings management to avoid a violation compared to shareholders at firms that violate a covenant but do not manage earnings. Thus, covenant-related earnings management may be in the best interests of shareholders and is not necessarily evidence of shareholder-manager agency conflicts.

Original languageEnglish (US)
Pages (from-to)311-343
Number of pages33
JournalEuropean Accounting Review
Issue number2
StatePublished - 2022


  • Debt covenants violations
  • Earnings management
  • Future firm performance

ASJC Scopus subject areas

  • Business and International Management
  • Accounting
  • Business, Management and Accounting (miscellaneous)
  • Automotive Engineering
  • History
  • Aerospace Engineering
  • Engineering (miscellaneous)
  • Economics, Econometrics and Finance (miscellaneous)


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