ACCOUNTING CHOICE IN TROUBLED COMPANIES

This paper studies accounting choice in 76 NYSE firms with persistent losses and dividend reductions (40% forced by binding covenants). We f ind that managers' accounting choices primarily reflect their firms' f inancial difficulties, rather than attempts to inflate income. Firms w ith and without binding covenants exhibit minor accrual differences in the ten years before the dividend reduction. In the dividend reductio n and following three years, the full sample exhibits large negative a ccruals that likely reflect the fact that 87% of sample firms engage i n contractual renegotiations - with lenders, unions, government, and/o r management - that provide incentives to reduce earnings.