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 p...

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Bibliographic Details
Published in:Review of accounting studies 2013-09, Vol.18 (3), p.783-823
Main Authors: Kim, Seil, Kraft, Pepa, Ryan, Stephen G.
Format: Article
Language:English
Subjects:
Accounting
Accounting/Auditing
Asymmetry
Balance sheets
Bond ratings
Business and Management
Corporate Finance
Credit default swaps
Credit ratings
Credit risk
Debt management
Financial statements
Hypotheses
Public Finance
Rating services
Ratings & rankings
Studies
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Summary: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.
ISSN:1380-6653
1573-7136
DOI:10.1007/s11142-013-9233-z