members of the SEC Office of Economic Analysis. 1.We follow prior research that examines the timing of a managerial action relative to an informational event and provides indirect evidence on the role of the threat of litigation in managerial decisions. For example, in Skinner 1994 the event is an earnings announcement and the managerial action is the disclosure of additional information; Skinner's evidence, which he interprets as consistent with reputational and legal incentives, is that negative earnings announcements are more frequently preempted by other corporate disclosures than positive earnings announcements. In Ke, Huddart, and Petroni 2003, the event is a break in the firm's string of consecutive earnings increases, and the managerial action is insider trading; Ke et al.'s evidence, which they interpret as consistent with an established legal jeopardy, is that managers stop selling immediately before a break in the firm's string of consecutive earnings increases. In Rogers 2008, the event is insider selling and the managerial action is the type (or quality) of the information that firms disclose; Rogers's evidence, which he interprets as consistent with reducing the threat of litigation, is that managers provide higher-quality disclosures before they sell their own company's shares.
Abstract. This paper contrasts technical default, debt service default and bankruptcy, and establishes that the valuation effects of their announcements are significant and increasingly severe. We show the events are interrelated. Specifically, we show that technical default is a timely warning of further distress insofar as adverse stock price effects of debt service default are mitigated if preceded by technical default. We find this arises in part because technical default increases the likelihood of further distress. The extent of the mitigation suggests reduced costs of future distress, likely because technical default triggers the early exercise of contractual rights that allow lenders to increase control over the firm. We also evaluate explanations of why debt service default and bankruptcy occur without firms first reporting technical default. Our analysis is based on the small sample of firms for which we can ascertain the terms of debt covenant constraints. Given this limitation, we find that it is not because debt agreements are written with too much covenant slack, nor do we observe material cases of nonreporting of covenant defaults. We conclude that covenants do not always provide warnings of future difficulties. Résumé. Les auteurs établissent la différence entre le manquement technique, le manquement au service de la dette et la faillite et font la preuve que les conséquences de ces indicateurs sur l'évaluation des entreprises sont appréciables et de plus en plus sérieuses. Ils démontrent que ces événements sont reliés entre eux et, plus précisément, que le manquement technique est un avertissement hâtif d'autres difficultés, dans la mesure où les conséquences néfastes du manquement au service de la dette sur le cours des actions sont atténuées si ledit manquement est précédé par un manquement technique. Les auteurs en viennent à la conclusion que cette situation se produit en partie parce que le manquement technique augmente la probabilité d'autres difficultés. L'ampleur de cette atténuation permet de supposer une réduction des coûts associés aux autres difficultés, sans doute parce que le manquement technique déclenche l'exercice anticipé des droits contractuels qui permettent aux bailleurs de fonds de resserrer le contrôle qu'ils exercent sur l'entreprise. Les auteurs évaluent également les facteurs qui expliquent pourquoi une entreprise peut manquer au service de la dette et faire faillite sans faire d'abord état d'un manquement technique. Leur analyse se fonde sur un petit échantillon d'entreprises à l'égard desquelles il est possible de s'assurer des conditions relatives aux contraintes imposées par les clauses restrictives des contrats de prêt. Compte tenu de cette limitation, les auteurs concluent que ce genre de situation n'est pas attribuable au fait que les contrats de prêt comportent des clauses trop permissives et n'observent pas non plus de cas probants de non‐divulgation d'information relative au manquement aux clauses restrictives. Ils en déduisent que les clauses restrictives ne...
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