How does accounting information reduce agency problems in relationships between management and debt holders? - Accounting information is used in debt covenants to reduce the risk to the lender. Accounting numbers are used to specify debt covenants. For example, a debt covenant may restrict leverage to a maximum of 60 per cent of total assets, thus reducing the lender’s risk of claim dilution. Debt covenants may also restrict dividend payouts as a function of profits, again using accounting information. Reported accounting numbers are used to monitor compliance with debt covenants. For example, the lender would refer to the statement of financial position to assess whether the leverage ratio exceeds the maximum allowed in the debt contract.
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