Municipal bond market recognition of pension reporting practices

The purpose of this study was to examine the usefulness of current municipal pension accounting disclosures for assessing municipal bond risks and returns. An empirical assessment of the association between various pension ratios and bond ratings, bond yields, and market risk revealed little explanatory power in the pension variables. We posit that the results probably stem from current practices that reduce the relevance and reliability of pension accounting numbers. Thus, standardization of practices and increased disclosures as proposed by the NCGA may have positive effects on the usefulness of pension disclosures for creditor decisions.     

Longitudinal accounting comparability and bond credit spreads: Evidence from China

This paper proposes a procedure to measure firms’ longitudinal accounting comparability and investigates whether it affects bond risk premiums. The results provide robust evidence that bonds of firms with more longitudinally comparable accounting information have lower credit spreads. This effect is stronger when the firms’ financial performance is poor and for bonds with speculative credit ratings. Results also reveal that firms with less longitudinally comparable accounting information are more informationally asymmetric and do have a higher expected default probability. Finally, the effects of the longitudinal and the cross-sectional comparability in reducing bond credit spreads are incremental to each other.     

Bond market access and investment

Prior research has shown that differential access to debt markets significantly affects capital structure. In this paper, we examine the effect of access to debt markets on investment decisions by using debt ratings to indicate bond market access. We find that rated firms are more likely to undertake acquisitions than nonrated firms. This finding remains even after accounting for firm characteristics, for the probability of being rated, and in matched sample analysis as well as in subsamples based on leverage, firm size, age and information opacity. Rated firms also pay higher premiums for their targets and receive less favorable market reaction to their acquisition announcements relative to non-rated firms. However, the average announcement returns to rated acquirers are non-negative. Collectively, these findings suggest that the lack of debt market access has a real effect on the ability to make investments as well as on the quality of these investments by creating underinvestment, instead of simply constraining overinvestment.     

The effects of governmental accounting methods on asset-acquisition decisions: A theoretical model and three case studies

This study explores possible effects of municipal accounting practices on asset-acquisition decisions. Theoretical decision models are developed using expenditure and depreciation accounting for reporting performance. The models suggest that expenditure accounting may lead to uneconomical leasing. Case studies of three cities focused on comparing present values of their leases to purchase alternatives and on interviewing department administrators. Significant uneconomical leases were found. The case studies suggest that a complete model of municipal administrators' acquisition decisions include consideration of accounting methods used to report performance; perceived risk of obsolescence; restrictions of grantors, third-party reimbursers and higher management; and administrators' background and training.     

A re-examination of the impact of credit ratings and economic factors on state bond yields

In this article we re-examine the impact of credit ratings and economic factors on state bond yields using a two-step model. In the first step, we adopt an ordered probit technique to obtain consistent estimates of state bond default risk. In the second step, we estimate state bond risk premiums using a regression analysis with a categorized risk variable obtained from the first step. Similar to Terza (1987) and Hsiao (1983), the model involves a categorized ordinal explanatory (rating) variable. However, our two-step model deals with a case where category thresholds are unknown and dependent on economic factors. The model provides consistent estimates for the effects of ratings and economic factors on state bond yields. Contrary to previous findings, we find that state bond yields are mainly affected by fundamental economic variables.     

INFORMATION OPACITY AND FITCH BOND RATINGS

We examine the marginal impact of Fitch ratings on the at‐issuance yields of industrial and utility bonds rated by Moody's and Standard & Poor's. We find that Fitch ratings reduce the yield premiums on information‐opaque bonds by about 30%, or 15 basis points. The finding is robust even when a Fitch rating exactly equals the two major ratings or their average. The findings suggest that Fitch ratings are not redundant but bring additional information to investors. Increased competition in the rating industry enhances the information efficiency of the bond market, and the existence of smaller rating agencies is economically justified.     

On the consistency of ratings and bond market yields

We study the consistency of the credit-risk orderings implicit in ratings and bond market yields. By analyzing errors in term structure estimates for bonds with particular ratings, we show that for significant periods, a quarter of some categories of high credit quality bonds are rated in a manner that is inconsistent with their pricing. Adjusting for economic determinants of spreads (tax, liquidity and risk premiums) and allowing for the dynamic adjustment of ratings and spreads largely eliminates the inconsistencies, however.     

The impact of junior debt issuance on senior unsecured debt’s risk premiums

Numerous studies have examined the impact of security issuance upon the value of pre-existing debt and equity but the focus has largely been on changes in equity value. We examine changes in senior unsecured debt risk premiums that accompany new junior debt issues. Additionally, we test several hypotheses regarding the potential impacts of junior debt issues. Extant theory suggests senior debt value may be threatened under certain conditions by the issuance of junior debt. Our results indicate that when junior debt replaces bank debt, senior default risk premiums experience abnormal declines. The result is broadly consistent with the elevation of the senior unsecured debt by way of the elimination of a separate and more senior class of debt claimants. In contrast, we also find that larger junior bond issues are associated with abnormal increases in senior risk premiums, broadly consistent with issue size being correlated with negative information about firm cash flows. We find strong evidence of interaction effects. For example, replacement of bank debt results in greater changes in default risk premiums the larger the issue size. We also find lower credit ratings magnify other effects. For example, if the junior debt issued matures before the outstanding senior unsecured bond, senior risk premiums experience abnormal increases for lower rated debt.     

Catastrophe bond pricing in the primary market: The issuer effect and pricing factors

COVID pandemic has highlighted the importance of hedging against catastrophic events, for which the catastrophe bond market plays a critical role. Our paper develops a two-level modelling and uses a unique, hand-collected dataset, which is one of the largest and most detailed datasets to date containing: 101 different issuers, 794 different bonds, spanning 1997–2020. We identify issuer effects robustly, isolating them from bond specific pricing effects, therefore providing more credible pricing factor results. We find that bond pricing and volatility are heavily impacted by the issuer, causing 26% of total price variation. We also identify specific issuer characteristics that significantly impact bond pricing and volatility, such as the issuer’s line of business accounting for up to 36% of total price variation. We further find that issuer effects are significant over different market cycles and time periods, causing substantial price variation. The size and content of our data also enables us to identify the counter-intuitive relation between bond premiums and maturity, and bond premiums and hybrid bond triggers.     

An empirical study of the value-relevance of using proportionate consolidation accounting for investments in joint ventures

This research examines bond risk premiums to determine whether creditors of companies with investments in joint ventures reflect legal or implicit measures of the debts of joint ventures. The legal view suggests that the amount of potential loss from an investment in a joint venture is limited to the investment. The implicit view suggests that the operations of the joint venture and the venturer are interdependent. Equity method accounting reflects the legal view and proportionate consolidation reflects the implicit view.The study examines whether bond risk premiums are more highly associated with accounting numbers from proportionate consolidation than equity method accounting. The study uses data from 10Ks, the Wall Street Journal, and Moody's Bond Record from May 1, 1995 through April 30, 1998. These 4 years are used because US interest rates were fairly stable during this period, which is an important factor when examining bond risk premiums. Additionally, the companies in the study needed to remain stable across the window of study – no mergers, acquisitions, buy-outs, or liquidations – in order to maintain a comparative sample over the entire time period. The risk premium model uses measures of default that change between equity method accounting and proportionate consolidation. Differences in the explanatory power of the model determine how creditors view the joint venture debts.The study shows that approximately half of equity investments represent investments in joint ventures. Furthermore, the average joint venture uses debt to finance about two-thirds of the assets. The results show that proportionate consolidation fails to improve the explanatory power of the model when examining the entire set of companies that invest in joint ventures. However, the data reject the null hypothesis of no improvement with proportionate consolidation when examining companies who guarantee the debt of their joint venture. The policy implication of this study indicates that a change to proportionate consolidation would provide more value-relevant information to creditors when companies guarantee the debt of the joint venture.     

THE INFORMATIONAL CONTENT OF BOND RATINGS

This paper explores the risk structure of interest rates. The focus is on whether yields on industrial bonds indicate that market participants base their evaluations of a bond issue's default risk on agency ratings or on publicly available financial statistics. Using a non-linear least squares procedure, the yield-to-maturity is related to Moody's rating, Standard and Poor's (S&P) rating, and accounting measures of creditworthiness such as coverage and leverage. Market yields are found to be significantly correlated with both the ratings and a set of readily available financial accounting statistics. These results indicate (1) that market participants base their evaluations of an issue's creditworthiness on more than the agencies' ratings and (2) that the ratings bring some information to the market above and beyond that contained in the set of accounting variables. The paper also asks whether the market views Moody's and Standard and Poor's ratings as equally reliable measures of risk or whether the market attaches more weight to one agency's ratings than the other. Finally, the hypothesis that the market pays more attention to the accounting measures and less to the ratings if the rating has not been reviewed recently is tested.     

The effect of unfunded pension liabilities on corporate bond ratings,default risk,and recovery rate

Unfunded pension liabilities lower ratings of non-senior secured bonds but do not affect ratings of senior secured bonds due to their higher seniority. Pension funding improvement (deterioration) is associated with bond rating upgrade (downgrade). Moreover, large unfunded liabilities increase bond default risk and reduce the recovery rate of bondholders after controlling for credit ratings, suggesting that bond ratings do not fully capture pension underfunding risk. Overall, our results highlight the important effects of unfunded pension obligations on bond ratings, default risk, and creditors’ payoff, and suggest that investors should look beyond bond ratings in making investment decisions.     

From T-Bills to Stocks: Seasonal Anomalies Revisited

This paper employed eleven data series which consist of stocks, bonds, bills, equity premiums, term premiums, and various default premiums to investigate whether January seasonality reported in existing literature is robust across different states of the economy as this has important trading implications. For the periods 1926–1990, small stocks, small stock premiums, low grade bonds, and default premiums (spread between high grade, low grade and government bonds) reveal January seasonality and that the seasonality is robust across different states of the economy except for low grade bond returns and default premiums. January seasonality for low grade bond returns and low grade bond default premiums are primarily driven by results found during periods of economic expansion. Overall, January seasonality is more evident during the economic expansion periods although the magnitude of default premiums is larger during periods of economic contraction. Furthermore, prior findings of strong summer equity returns are primarily driven by the results found during the periods of economic contraction. It is also found that equity returns are generally higher during periods of economic expansion.     

The impact of narrative disclosure readability on bond ratings and the cost of debt

Prior research on the determinants of credit ratings has focused on rating agencies’ use of quantitative accounting information, but the there is scant evidence on the impact of textual attributes. This study examines the impact of financial disclosure narrative on bond market outcomes. We find that less readable financial disclosures are associated with less favorable ratings, greater bond rating agency disagreement, and a higher cost of debt. We improve causal identification by exploiting the 1998 Plain English Mandate, which required a subset of firms to exogenously improve the readability of their filings. Using a difference-in-differences design, we find that the firms required to improve the readability of their filings experience more favorable ratings, lower bond rating disagreement, and lower cost of debt. Collectively, our evidence suggests that textual financial disclosure attributes appear to not only influence bond market intermediaries’ opinions but also firms’ cost of debt.     

Deferred Taxes and Bond Ratings: A Canadian Case

This paper explores the usefulness of the current Canadian Institute of Chartered Accountants standard on accounting for income taxes in bond rating decisions by credit analysts. Bond rating prediction models using accounting variables generated with alternate treatment of income taxes, have been developed. The analysis indicates that additional information presented by the above standard has not contributed significantly to the bond raters' decision making process.     

Accounting and strategising: A case study from new product development

This paper explores the relationship between accounting and strategy in a context that is characterised by pluralistic demands and high uncertainty about outcomes. By way of an ethnographic field study in an R&D intensive company, we analyse new product development (NPD) projects and the way in which decisions and practices concerning these projects are accounted for. Building upon a practice theory perspective, we find that actors account for the appropriateness of NPD practices not only or primarily on the basis of accounting information, but also by “strategising”, i.e. by mobilising different strategic objectives to which these practices are supposed to contribute. We argue that this has to do with the ambiguous demands on NPD and the limits of calculability inherent in NPD design decisions. At the same time, accounting information is not necessarily irrelevant in such a case; it can enter the picture as a general understanding that guides actors’ strategising efforts by reminding them of the ultimate importance of financial numbers.     

The effect of CEO power on bond ratings and yields

We argue that executives can affect firm outcomes only if they have influence over crucial decisions. This study explores the impact of CEO power or CEO dominance on bond ratings and yield spreads. We find that credit ratings are lower and yield spreads higher for firms whose CEOs have more decision-making power. To further investigate why bondholders are concerned about CEO power, we show that powerful CEOs tend to maintain an opaque information environment. Bondholders demand higher yields because it is difficult for them to monitor managers in firms with powerful CEOs. Taken together, the results suggest that bondholders perceive CEO power as a critical determinant of the cost of bond financing.     

Capitalisation of Intangibles — A Review of Current Practice and the Regulatory Framework

This paper reports on capitalisation practices of Australian managers for a large sample of firms in the 1993–97 period, and on accounting regulatory issues in relation to intangibles during and after this period. The data show diversity in capitalisation practices in 1993–97, which we suggest is a consequence of abstract conceptual bases for capitalisation decisions under the Australian regulatory framework. The analysis indicates the framework retains traditional emphasis on conservatism and reliable measurement while providing managers with substantial accounting discretion to capitalise intangible assets. We conclude there is an imperative for research investigating capitalisation decisions for intangibles to guide any further regulation.     

CSR in the bond market: Pricing stakeholders and the moderating role of the institutional context

This study examines the impact of corporate social performance (CSP) on the spreads and credit ratings of corporate bonds on a global scale. The relationship is examined within the national legal and institutional environment and with regard to specific stakeholder practices. We construct and use a unique longitudinal, international dataset with a total of 5280 bond issues dating from 2003 to 2018 and spanning 40 countries worldwide.We provide evidence that more responsible firms benefit from lower bond spreads and improved bond ratings, while a higher degree of CSR-related controversies penalizes firms on both dimensions. Various, but not all, stakeholder relationships appear to generate a significant impact on spreads and bond ratings, with shareholders remaining crucial in both civil and common law countries, opposite to literature findings so far. Corporate governance is corroborated as a primary concern also in the debt market for common law economies, while societal stakeholders assume significance for civil law systems. Finally, findings highlight that stronger regulation and government involvement do not further promote the role of CSP in the debt market. On the other hand, free public criticism and media scrutiny generate a more pronounced effect of CSP on bond pricing providing support for the rewards associated with voluntary and proactive CSR.     

Do Bond Covenants Affect Borrowing Costs?

High yield bond investors spend a great deal of time studying covenants. They even hire specialized consultants to help them interpret the dense language of indentures. But for all that, does a company's decision to offer strong rather than weak covenants—or to offer covenants at all—have a measurable impact on its borrowing costs? There is surprisingly little evidence that variation in credit risk premiums reflects the presence or absence of covenants. Taking advantage of a newly available kind of data—Moody's Investors Service's Covenant Quality (CQ) ratings, which were initiated in 2011—the authors studied each newly issued U.S. high yield bond beginning in 2011 using Moody's CQ ratings, where a rating of “1” represents the strongest covenant rating and “5” the weakest. The authors hypothesize that if investors are willing to pay for covenant protection, bonds with weak CQ scores should have spreads that are higher, on average, than the medians of the bonds in their rating group. What they found, however, was that even bonds rated CQ5, indicating negligible protection, had spreads that were only 9.54 basis points higher than the median of companies with the same credit rating. The authors also found, contrary to their initial supposition, that higher yields were associated with stronger covenants, suggesting that investors demand more protection on issues they view as having greater credit risk than other equivalently rated issues.