Financial statement comparability and credit risk

Seil Kim, Pepa Kraft () and Stephen G. Ryan
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Seil Kim: New York University
Pepa Kraft: New York University
Stephen G. Ryan: New York University

Review of Accounting Studies, 2013, vol. 18, issue 3, No 8, 783-823

Abstract: 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.

Keywords: Comparability; Corporate credit risk; Credit rating agency; Bond market liquidity (search for similar items in EconPapers)
JEL-codes: G24 G32 M41 (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1007/s11142-013-9233-z

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