This master thesis attempts to contribute to the existing earnings management literature by examining whether tax avoidance incentives affect opportunistic accounting choices in distress conditions. To address this issue, it investigates 2668 companies in the quarters around breach of debt covenant spanning from 1996 to 2006. This allows to analyze two distress scenarios: first, whether the companies having the opportunity to minimize tax expenses and thus improve their financial stability, would deliberately switch from engaging in aggressive upwards real earnings management to tax considerations to mitigate the potential consequences of technical default; second, whether the companies facing increased lender's scrutiny after subsequent violation are compelled to switch by the creditor. The results indicate that tax considerations do not deter misreporting in the quarters around debt covenant violation. This thesis further provides evidence against the debt covenant hypothesis: the companies in the analyzed sample engaged in negative revenue manipulation in the quarters of new breach of debt covenant and in the quarters in which the firms remained in violation. In additional analysis, it was found that the above relationship is more prominent for the companies exhibiting poor financial performance.

This study examines whether financial analysts produce larger amounts of research output and whether their research is more valuable for investors following a debt covenant violation (DCV, hereafter). After a DCV, investor uncertainty about firm value and information asymmetry among stakeholders likely increases. It is therefore difficult for investors to assess firm prospects, resulting in increased demand for firm-specific information. Sell-side analysts, as sophisticated information intermediaries, are skilled at gathering and processing information; thus they are well-suited to provide more research output in response to increased investor demand. I predict and find that equity analysts provide a larger amount of research, proxied by recommendation revisions and earnings forecast revisions, after a DCV. I also document an incremental association between a DCV and analyst research production for firms with less financial flexibility, firms with low institutional ownership, and firms covered by more experienced analysts. In addition, I find evidence that analyst research becomes more valuable and that uncertainty-adjusted analyst forecast errors decrease following a DCV. These results suggest that a change in a firm’s information environment associated with a DCV has significant influence on investors and equity analysts besides the economic consequences documented in prior literature.