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Does Other Comprehensive Income Volatility Influence Credit Risk and the Cost of Debt?

Author

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  • May Xiaoyan Bao
  • Matthew T. Billett
  • David B. Smith
  • Emre Unlu

Abstract

We examine the usefulness of other comprehensive income (OCI) to debt investors in nonfinancial companies. Motivated by Merton's (1974) real options framework, we construct a measure of incremental OCI volatility, designed to capture the effect of OCI on overall firm asset volatility, which is a primary driver of credit risk in Merton's (1974) model. We find that the volatility of incremental OCI influences the likelihood of default, credit ratings, and the cost of debt. Overall, our evidence suggests that creditors use information from OCI in their assessment of firm credit risk and in pricing debt contracts. La volatilité des autres éléments du résultat global influe‐t‐elle sur le risque de crédit et le coût des capitaux empruntés? Les auteurs s'interrogent sur l'utilité des autres éléments du résultat global (AÉRG) pour les investisseurs en titres d'eûmprunt de sociétés non financières. Le cadre des options réelles de Merton (1974) leur suggère la création d'un indicateur de volatilité marginale des AÉRG permettant d'évaluer l'incidence des AÉRG sur la volatilité globale de l'actif de l'entreprise, un inducteur de risque de crédit de premier plan dans le modèle de Merton (1974). Les auteurs constatent que la volatilité marginale des AÉRG influe sur la probabilité de manquement, la notation du crédit et le coût des capitaux empruntés. Dans l'ensemble, les données recueillies semblent indiquer que les créanciers utilisent l'information livrée par les AÉRG dans leur évaluation du risque de crédit de l'entreprise et dans l'établissement du prix des contrats d'emprunt.

Suggested Citation

  • May Xiaoyan Bao & Matthew T. Billett & David B. Smith & Emre Unlu, 2020. "Does Other Comprehensive Income Volatility Influence Credit Risk and the Cost of Debt?," Contemporary Accounting Research, John Wiley & Sons, vol. 37(1), pages 457-484, March.
    • Handle: RePEc:wly:coacre:v:37:y:2020:i:1:p:457-484
    DOI: 10.1111/1911-3846.12548
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    2. Yiting Cao & Qi (Flora) Dong, 2020. "Does reporting position affect the pricing of the volatility of comprehensive income?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(9-10), pages 1113-1150, October.
    3. Sikalidis, Alexandros & Bozos, Konstantinos & Voulgaris, Georgios, 2023. "Asymmetric effects of fair value adjustments on dividend policy," International Review of Financial Analysis, Elsevier, vol. 90(C).
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    5. Masaki KUSANO, 2022. "Recognition versus Disclosure and Managerial Discretion: Evidence from Japanese Pension Accounting," Discussion papers e-22-008, Graduate School of Economics , Kyoto University.
    6. Lee, Chien-Chiang & Wang, Chih-Wei & Hsieh, Hsin-Yi & Chen, Wen-Ling, 2023. "The impact of central bank digital currency variation on firm's implied volatility," Research in International Business and Finance, Elsevier, vol. 64(C).

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