Contract Maturity and Assets Other Than Those in Book Value

Abstract

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.