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Accounting-based expected loss given default and debt contract design

Author

Listed:
  • Dan Amiram

    (Coller School of Management, Tel Aviv University)

  • Edward Owens

    (University of Utah)

Abstract

We investigate an unexplored channel—loss given default (LGD)—through which accounting information can shape the design of debt contracts. Using a sample of defaulted bonds, we find that borrower accounting information available at contract initiation possesses significant power for predicting realized LGD at the subsequent default date. We then use this model to construct an accounting-based measure of expected LGD at the contracting date for a large sample of bond issuances. We find that this measure is positively associated with issuance date interest spread and covenant use, and document that these relations are not artifacts of an association between LGD and probability of default. We then show that accounting-based expected LGD has a stronger association with issuance date spread when the borrower’s underlying accounting is more conservative and when the accounting-based LGD predictors are more persistent. Our results increase our understanding of both the informational role and contracting role of accounting information.

Suggested Citation

  • Dan Amiram & Edward Owens, 2024. "Accounting-based expected loss given default and debt contract design," Review of Accounting Studies, Springer, vol. 29(3), pages 2437-2467, September.
    • Handle: RePEc:spr:reaccs:v:29:y:2024:i:3:d:10.1007_s11142-023-09772-x
    DOI: 10.1007/s11142-023-09772-x
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    More about this item

    Keywords

    Debt contracts; Loss given default; Accounting properties; Stepwise regression;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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