Does Restricting Managers' Discretion through GAAP Impact the Usefulness of Accounting Information in Debt Contracting?†

We examine whether restricting managers' discretion through GAAP impacts the usefulness of accounting information in debt contracting. Our study informs standard setters and regulators regarding the debt contracting implications of limiting managers' discretion via accounting standards. We predict and find that under more restrictive standards, lenders make more non-GAAP modifications to GAAP-based performance measures, suggesting that restrictions of managers' discretion reduce the usefulness of accounting information. We perform two additional analyses to enhance identification. First, in line-item-level analysis, we document a positive relation between the exclusion of specific nonrecurring items from contractual definitions of earnings and the number of restrictions in the GAAP standards that apply to each specific item each year. Second, using difference-in-differences tests around standard changes, we find that the propensity to exclude items varies positively with changes in the restrictiveness of related standards. Moreover, we predict and find that restrictive standards are also positively associated with loan spreads but significantly less so when lenders adjust GAAP numbers in loan contracts. Overall, this study improves our understanding of how attributes of accounting standards impact the usefulness of accounting information.