Does the Variability of Other Comprehensive Income (OCI) Play a Role in the Determination of Cost of Debt, Capital Structure and Credit Ratings?
Does the Variability of Other Comprehensive Income (OCI) Play a Role in the Determination of Cost of Debt, Capital Structure and Credit Ratings?
Date
2017-08-28
Authors
Bao, Xiaoyan
Billett, Matthew
Smith, David
Unlu, Emre
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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.
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credit risk,
OCI,
Volatility
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