Why is Accounting Information Important to Bondholders?

• In Event: Research Papers Dialogue Session—FARS and Auditing

Abstract

We investigate the relevance of accounting information for bondholders. Our results imply that accounting signals provide information about the firm’s debt sensitivity to aggregate cash flow (CF) and discount rate (DR) news. The importance of a given accounting information depends on 1) the mix of CF and DR information, 2) the firm’s proximity to default, and 3) the aggregate credit conditions. Specifically, the sensitivity of debt to news increases as firms get closer to default and as aggregate credit conditions worsen. However, the latter is more important. We incorporate these insights into a dynamic trading strategy that earns significant risk adjusted returns. The results are robust after controlling for liquidity and transaction costs.

Authors

• Alex Petkevich, University of Toledo

• Doina C. Chichernea, University of Toledo

• Kainan Wang, University of Toledo