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ItemContract Maturity and Assets Other Than Those in Book Value( 2017-08-31)Agency theory suggests that, when agency costs are high, creditors place more weight on the value of assets as recorded on the balance sheet (“recorded” assets) and less weight on assets that are valued by capital providers but not recorded on the balance sheet (“unrecorded” assets). The essence of the argument is that balance sheet recorded assets are more likely to be recoverable if there is a default. However, extant evidence is not consistent with this suggestion when contract maturity is used as a proxy for agency costs. We provide an explanation for this apparent anomaly. We show that the sensitivity of credit default swap (CDS) spreads (which are an indicator of credit risk) to changes in unrecorded assets increases with the maturity of the CDS while the sensitivity to change in recorded assets does not change with maturity. That is, unrecorded assets affect the CDS market’s assessment of future cash flows available for principal and interest payments more so in the long term than in the short term. We attribute this increase in sensitivity to a longer time horizon and higher projected growth rates in the future cash flows generated by unrecorded assets.
ItemLabor Unemployment Insurance and Firms' Future Performance( 2017-08-30)Labor unemployment insurance has been an ongoing topic in economics and finance. Recent studies in accounting and finance have examined the effect of labor unemployment insurance on earnings management (Dou, Khan, and Zou 2016), corporate voluntary disclosure (Ji and Tan 2016), and corporate financial structure (Agrawal and Matsa 2013). This paper investigates the association between unemployment insurance benefits and firms’ future performance. We find that higher unemployment benefits are associated with higher firms’ future earnings and cash flows. Furthermore, we examine how unemployment benefits affect the volatility of firms’ future performance. We find that the magnitude of unemployment benefits is associated with a lower degree of volatility of firms’ future earnings and cash flows, suggesting that the risk mitigation effect of unemployment insurance helps to explain the positive relationship between unemployment insurance and firms’ future performance. Finally, we find that the positive association between unemployment benefits and firms’ future performance is more pronounced for firms with larger changes in labor force, and that the negative association between unemployment benefits and volatility of firms’ future performance is more pronounced for firms with higher labor force volatility and capital structure volatility. Overall, our results suggest that labor unemployment insurance has a strong association with firms’ future performance and volatility of firms’ future performance.
ItemIncreased creditor protection in bankruptcy and trade credit: Evidence from the 2005 BAPCPA( 2017-08-28)We examine whether the increased creditor protection under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) affects suppliers’ provision of trade credit to their customers with high default risk. Employing a difference-in-differences analysis for a sample of U.S. public firms during 2002-2008, we find that suppliers whose customers have high default risk extend more trade credit after BAPCPA. We also find that this relation exists when suppliers have stronger reliance on their customers and when customers exhibit fewer risk characteristics. Overall, our results indicate that the increased creditor protection in bankruptcy induces suppliers to offer more trade credit to customers with high default risk during the ordinary course of business. Our findings have policy implications given the heated debate on the BAPCPA’s effect on Chapter 11 bankruptcy process.
ItemDoes the Variability of Other Comprehensive Income (OCI) Play a Role in the Determination of Cost of Debt, Capital Structure and Credit Ratings?( 2017-08-28)In this paper, we focus on the usefulness of other comprehensive income (OCI) to debt investors. We conceptualize OCI’s usefulness to be its risk relevance. We hypothesize that credit risk is associated with OCI volatility and so we contribute to the debate whether this volatility is viewed by creditors as capturing useful information about debt risk or just “noise.” Specifically, we consider whether OCI’s volatility that is linked to accounting standards in the recent two decades is associated with cost of debt, non-price terms of debt contracting (i.e. covenants, security), capital and maturity structure, and credit ratings. We construct three samples to conduct our tests: (1) a new loan sample from Dealscan and (2) a comprehensive sample from COMPUSTAT and (3) credit ratings sample. We find strong evidence that higher volatility of OCI is associated with a higher cost of debt, higher likelihood of collateral requirement, and stronger credit rationing (lower use of debt). We also find statistically significant but economically weak evidence that OCI volatility is related to shorter debt maturity and lower credit ratings. Overall, our evidence suggests that OCI volatility provides useful information to credit markets and shapes debt contracting and the firm’s capital structure accordingly.