Financial statement comparability and credit risk

Financial statement comparability and credit risk Prior research shows that firms’ financial statement comparability improves the accuracy of market participants’ valuation judgments and thus may reduce firms’ costs of capital. Distinct from prior research focusing on the equity market, we develop measures of comparability relevant to debt market participants based on the within-industry variability of Moody’s adjustments to reported accounting numbers for the purposes of credit rating. We examine two sets of adjustments: (1) to the interest coverage ratio and (2) to non-recurring income items. We validate these comparability measures by providing evidence that greater comparability is associated with lower frequency and magnitude of split ratings by credit rating agencies. We predict and find that greater comparability is associated with (1) lower estimated bid-ask spreads for traded bonds, (2) lower credit spreads for both bonds and five-year credit default swaps, and (3) a steeper one- to five-year credit default swap term structure. Our results are consistent with financial statement comparability reducing debt market participants’ uncertainty about and pricing of firms’ credit risk. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Financial statement comparability and credit risk

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Publisher
Springer US
Copyright
Copyright © 2013 by Springer Science+Business Media New York
Subject
Economics / Management Science; Accounting/Auditing; Finance/Investment/Banking; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-013-9233-z
Publisher site
See Article on Publisher Site

Abstract

Prior research shows that firms’ financial statement comparability improves the accuracy of market participants’ valuation judgments and thus may reduce firms’ costs of capital. Distinct from prior research focusing on the equity market, we develop measures of comparability relevant to debt market participants based on the within-industry variability of Moody’s adjustments to reported accounting numbers for the purposes of credit rating. We examine two sets of adjustments: (1) to the interest coverage ratio and (2) to non-recurring income items. We validate these comparability measures by providing evidence that greater comparability is associated with lower frequency and magnitude of split ratings by credit rating agencies. We predict and find that greater comparability is associated with (1) lower estimated bid-ask spreads for traded bonds, (2) lower credit spreads for both bonds and five-year credit default swaps, and (3) a steeper one- to five-year credit default swap term structure. Our results are consistent with financial statement comparability reducing debt market participants’ uncertainty about and pricing of firms’ credit risk.

Journal

Review of Accounting StudiesSpringer Journals

Published: Jun 13, 2013

References

  • Financial ratios, discriminant analysis and the prediction of corporate bankruptcy
    Altman, E. I.
  • When does information asymmetry affect the cost of capital?
    Armstrong, C. S.; Core, J. E.; Taylor, D. J.; Verrecchia, R. E.
  • Incentives versus standards: Properties of accounting income in four east asian countries
    Ball, R.; Robin, A.; Wu, J. S.
  • The role of accruals in asymmetrically timely gain and loss recognition
    Ball, R.; Shivakumar, L.
  • The illiquidity of corporate bonds
    Bao, J.; Pan, J.; Wang, J.
  • Are IFRS-based and US GAAP-based accounting amounts comparable?
    Barth, M.; Landsman, W. R.; Lang, M.; Williams, C.
  • Who is my peer? A valuation-based approach to the selection of comparable firms
    Bhojraj, S.; Lee, C.
  • Corporate yield spreads and bond liquidity
    Chen, L.; Lesmond, D. A.; Wei, J.
  • Information effects on the bid-ask spread
    Copeland, T. E.; Galai, D.

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