Creditor Rights, Conflict of Interest Among Creditors, and Borrowers’ Accounting Conservatism: Evidence From Anti-Recharacterization Laws

Using the staggered adoption of anti-recharacterization laws (ARLs) as an exogenous shock to creditor rights, we study the effects of creditor rights on borrowers’ accounting conservatism. By forbidding securitized assets from being recharacterized as collateral for secured debt, ARLs protect securitization creditors at the expense of non-securitization creditors. Given the conflict of interest between these creditors, we argue that non-securitization creditors may demand more conservative accounting in response to their decreasing rights. Consistent with this argument, we find an increase in borrowers’ accounting conservatism after ARL adoption. To further support our demand-side argument, we present evidence that the effect of ARLs on accounting conservatism is stronger for borrowers with a higher likelihood of securitizing assets, those with unsecured creditors, and those with loan contracts that include more financial covenants. We also find a stronger effect for borrowers that are more likely to default, as captured by their credit risk, and for borrowers that are more difficult to monitor, as indicated by their poor information environment. Overall, our study establishes a link between creditor rights and borrowers’ accounting conservatism. We also add to the literature by offering novel evidence that creditors’ demand for accounting conservatism shapes borrowers’ financial reporting practices.