Financial statement comparability and credit risk

For example, it is not particularly difficult for market participants to capitalize minimum lease payment disclosures for each of the first five years of operating leases required by FAS 13. Hence, if the calculated variability of Moody’s adjustments results solely from some firms having more operating leases with minimum lease payments in the first five year terms than others, then this variability will not indicate meaningful lack of comparability. However, it is more difficult to capitalize the disclosed lump sum of minimum lease payments beyond five years required by FAS 13. It is more difficult still to deal with lease contractual features that yield payments that are highly likely to occur but not deemed to be minimum lease payments, such as contingent lease payments and payments associated with the exercise of most renewal options, for which FAS 13 requires only descriptive, nonquantitative disclosures. Non-lease examples involving highly judgmental adjustments include securitizations with significant but not complete risk transfer and transitory income items with operating characteristics or that are in the same direction period after period.

These papers are related to a large prior stream of literature that uses the strength of the contemporaneous relation between stock returns and accounting numbers or the magnitude or variability of valuation multiples as proxies for relative financial reporting quality, for example, of different accounting systems internationally (Joos and Lang 1994; Land and Lang 2002), or to identify peer firms (Bhojraj and Lee 2002).

Prior research suggests that credit spreads in CDS markets are less affected by illiquidity than credit spreads in bond markets (Jorion and Zhang 2007; Longstaff et al. 2005).

We conduct a robustness test where we drop days with positive covariances.

Because we use Eq. (6) for construct validation purpose only, we omit compacctind because it is a competing comparability measure and bsmprob because average_rating_bond is a more relevant default measure for credit rating agencies.

We conduct robustness tests where we recalculate the estimated bid-ask spread without any days with positive covariances and find that results are robust to this specification.