Credit Default Swaps and Managers’ Voluntary Disclosure

Abstract

We investigate how the availability of traded credit default swaps (CDSs) affects the referenced firms’ voluntary disclosure choices. CDSs enable lenders to hedge their credit risk exposure, weakening their incentives to monitor borrowers. We predict that reduced lender monitoring in turn leads shareholders to intensify their monitoring and demand increased voluntary disclosure from managers. Consistent with this expectation, we find that managers are more likely to issue earnings forecasts and forecast more frequently when traded CDSs reference their firms. We further find a stronger impact of CDS availability on firm disclosure when (1) lenders have higher ability and propensity to hedge credit risk using CDSs, and (2) lender monitoring incentives and monitoring strength are weaker. Consistent with an increase in shareholder demand for public information disclosure induced by a reduction in lender monitoring, we find a stronger effect of CDSs on voluntary disclosure for firms with higher institutional ownership and stronger corporate governance. Overall, our findings suggest that firms with traded CDS contracts enhance their voluntary disclosure to offset the effect of reduced monitoring by CDS‐protected lenders.

The externalities of credit default swaps on stock return synchronicity

“…A lower value of stock return synchronicity represents weaker 4 In our DID analysis, we exclude the first partial year of CDS trading and define the CDS TRADING dummy as one starting from the first full fiscal year following CDS initiation; zero, otherwise. The main reasons for this treatment are as follows: (a) It is hard to identify the timing of sales occurrence during the year and compare it with CDS initiation date, and (b) the supplier and the capital market need time to digest the CDS financial innovation information, and react to the information contained in CDS trading (Bai et al, 2017;Kim et al, 2018). comovement between individual stock returns and market or industry returns; in other words, it leads to an enhancement of firm-specific information.…”

“…6 To address this endogeneity issue, we formulate an instrumental variable (IV) and perform two-stage IV regression. To extract the exogenous component of the sales to customers, in the first-stage regression we follow previous studies by regressing sales to customer on one additional IV, foreign exchange derivative usage by firm's lenders and underwriters (FX; Ashcraft & Santos, 2009;Kim et al, 2018;Martin & Roychowdhury, 2015;Saretto & Tookes, 2013;Subrahmanyam et al, 2014Subrahmanyam et al, , 2017. 7 Then, in the second-stage regression, we take the predicted value of the first-stage regression as the key variable of interest.…”

“…However, the existing research on the impact of CDS trading all faces the potential endogeneity issue (Ashcraft & Santos, 2009;Kim et al, 2018;Martin & Roychowdhury, 2015;Saretto & Tookes, 2013;Subrahmanyam et al, 2014Subrahmanyam et al, , 2017. One of the concerns is that stock return synchronicity and sales to CDS reference customers are jointly determined.…”

Refinancing Risk and Disclosure of Corporate Investment

“…However, recent studies suggest that although lenders' demand for information itself may not affect firm's information environments, lenders' economic activities may do so. For example, Kim et al (2018) show that a decrease in lenders' monitoring increases shareholders' demand for information and borrowers' disclosures. Adding to these recent studies, we examine corporate disclosure incentives when firms seek debt refinancing.…”

“…Gul and Goodwin (2010) document that short term debt is associated with increased monitoring. Kim et al (2018) show that reduced lender monitoring due to CDS trading increases shareholders' demand for information. Combining the findings of these two studies predicts a negative relation between refinancing risk (higher monitoring) and capital expenditure forecasts.…”