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GAAP Goodwill and Debt Contracting Efficiency: Evidence from Net-Worth Covenants
Richard Frankel, Washington University in St. Louis
Chandra Seethamraju, Mellon Capital Management
Tzachi Zach, Washington University in St. Louis
ABSTRACT. We study the role of goodwill in promoting contracting efficiency and the effect of SFAS 141 and 142 on this role. We provide three main results. First, when a lending agreement contains some type of minimum-net-worth covenant, the probability of a tangible-net-worth covenant is decreasing in the borrower’s goodwill. Second, the use of tangible-net-worth covenants has increased since the promulgation of SFAS 141 and 142. Finally, covenant slack is larger when tangible-net-worth covenants are used. These results suggest that contracting parties realize efficiency gains by permitting borrowers’ actions to be restricted by the value of GAAP goodwill. However, the salutary effects of goodwill on contracting efficiency have been reduced due to recent changes in GAAP.
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