Active CDS Trading and Managers’ Voluntary Disclosure

• In Event: Market Participants and Voluntary Disclosure

Abstract

We investigate how the development of the credit default swap (CDS) market affects firms’ voluntary disclosure choices. The CDS market has been criticized for its vulnerability to insider trading by informed lenders who trade on borrowers’ private information. We predict that the threat of private information revelation in the spreads of actively traded CDSs will pressure managers into enhancing their voluntary disclosures to mitigate the litigation and reputation risks associated with non-disclosure. Consistent with our prediction, we find that managers are more likely to issue earnings forecasts when their firms have actively traded CDSs. Our results also suggest that liquid CDSs discipline managers to disclose bad news earnings forecasts, despite their career- and wealth-related incentives to withhold adverse information. In addition to disclosures via management forecasts, we document that liquid CDSs also enhance disclosure via firm-initiated press releases. Our findings suggest that informed trading by lenders in the CDS market results in a positive externality for capital markets by eliciting enhanced voluntary disclosures, thus contributing to a richer information environment.

Authors

• Jae Bum Kim, Singapore Management University

• Pervin K Shroff, University of Minnesota, Minneapolis

• Dushyantkumar Vyas, University of Toronto

• Regina Wittenberg-Moerman, The University of Chicago