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Review of Accounting Studies

Erschienen in:

19.10.2016

The changing relevance of accounting information to debt holders over time

verfasst von: Dan Givoly, Carla Hayn, Sharon Katz

Erschienen in: Review of Accounting Studies | Ausgabe 1/2017

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Abstract

A number of studies have examined the change over time in the information content of accounting numbers to stockholders. However, the stockholders’ perspective is not necessarily identical to that of debt holders. The two groups face different risks and rewards, and thus their informational needs are not the same. We examine the change in the information content of accounting numbers over time from the debt holders’ perspective and hypothesize about the economic and reporting factors likely to affect this change. Using the association between accounting numbers and bond valuation and returns, we find that the information content to debt holders has increased over time. In contrast, but consistent with prior studies, we find that the information content to equity holders has declined. The results suggest that the increased information content to debt holders is related to changes in credit risk and to reporting factors such as the increase in reporting conservatism, the shift towards fair value accounting, and the increase in the frequency of losses. The findings contribute to the scant literature on the use of accounting information by debt holders and the extent to which financial reporting meets their unique needs.

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At the end of 2014, the U.S. corporate bond market value was $7.8 trillion (Securities Industry and Financial Markets Association; see http://www.sifma.org/research/statistics.aspx), and the private debt market was estimated at $11 trillion (Thomson One). Combined, the total market value of debt is thus approximately $18.8 trillion—more than 70 % of the market value of equity, which was estimated to be $26.3 trillion (see the World Federation of Exchanges report on the aggregate market value of shares traded on the NYSE and NASDAQ OMX; see http://www.world-exchanges.org/statistics).

See FASB Statement of Financial Accounting Concepts No. 8 2010, paragraph OB2. A similar objective is expressed in the conceptual framework of the IAS (1989)—The Conceptual Framework for Financial Reporting.

Among the few studies that adopt the debt holders’ perspective are Plummer and Tse (1999), Shi (2003), Ball et al. (2008a), Easton et al. (2009), Elliott et al. (2010), Sridharan (2011), Gkougkousi (2014), and DeFond and Zhang (2014).

For a summary of these concerns, see Francis and Schipper (1999).

Stock data has been easy to obtain since the advent of the Center for Research in Security Prices (CRSP) in 1960, with return data available for years as early as 1925 (for NYSE firms). Bond data availability is more limited. The Mergent Fixed Income Securities Database (FISD) contains bond exchange transactions beginning in 1994 but only for insurance companies. The Trade Reporting and Compliance Engine’s (TRACE) Corporate Bond Database provides bond prices beginning in 2002 with more comprehensive data available beginning only in 2005.

The frequency of losses and earnings declines could mirror reporting factors. In particular, accounting conservatism in the form of a more timely recognition of losses has been shown to affect earnings variability and skewness (see Givoly and Hayn 2000).

Uncertainty of the intangible investments’ value exists regardless of whether they are capitalized or not. If capitalized, their cost is unlikely to represent their fair value except, perhaps, immediately following their acquisition or recognition of their impairment. Whether capitalization is beneficial to creditors is an open question. There is some evidence that capitalization of intangibles may reduce the rate of false predictions of bankruptcy (see Franzen et al. 2007). Yet, Shi’s (2003) findings suggest that the added risk conveyed by capitalized R&D overshadows the benefits to bond holders.

Matching by coupon rate and years-to-maturity as done by Easton et al. (2009) leads to very similar results.

An alternative derivation whereby the expected return is measured from the market model yields similar inferences.

Equation (2) is similar to that used by Francis and Schipper (1999). Alternative equity valuation specifications used in the literature (including those in which the variables are deflated by the market value of equity) produce similar results.

Extreme observations are handled using two alternative approaches (see Francis and Schipper (1999)). In one, each of the stock regressions is estimated from data in which all variables are truncated at the tails of the distributions (at 1 and 99 %). Alternatively, observations identified as influential by the Belsley et al. (1980) diagnostic analysis (i.e., a Studentized residual greater than 3 or a Cook’s D Statistic greater than 1) are removed. Both approaches produce similar results.

To estimate PROB, we follow the procedure developed by Hillegeist et al. (2004) and used by Vassalou and Xing (2004). The primary variables in the estimation of PROB are the market value of equity, the standard deviation of equity returns, and total debt.

Other research that uses models with similar accounting variables includes Ball et al. (2008a), Dou (2014), and Kovner and Wei (2014).

This return regression is similar to that used by Francis and Schipper (1999) except that we measure unexpected earnings using analyst forecasts rather than a mechanical model and do not include the book value of equity as an explanatory variable. Inclusion of this variable in our regression does not affect the results.

Interactive Data provides third-party bond prices and other financial services. Its subscribers include thousands of financial institutions worldwide, ranging from central banks to large investment banks. Other research using this database includes Hancock and Kwast (2001), Hand et al. (1992), Hemler (1990), Dudney and Geppert (2008), Cooper and Shulman (1994), Shulman and Bayless (1993), and Gay and Manaster (1991).

The decline in the number of bond issues in 2007 is also likely due to the shift of issuers towards (high-yield) bonds through private placement (144A offerings). These bonds are not included in our sample.

These cutoff points reflect the tradeoff between the need for a minimum sample size each year and the objective of having a sample of bonds that have similar characteristics and are of relatively high liquidity.

Additional cutoff points were applied to those years in which the mean or median value of one or more of the bond characteristics deviated considerably from other years as follows: the issue size for years after 1999 was limited to a maximum value of $450 million (in 2013 dollars), and the values of duration and maturity were capped at the 20 % extreme values of the respective distributions for years before 1984 and 1988, respectively. The results are similar to those obtained without these restrictions (see discussion in the robustness test in Sect. 7.2).

The estimated parameters of the bond valuation and return models are presented in Appendix 2.

This trend line regression is similar to Francis and Schipper (1999). It is estimated as β₁ in the regression: Adj. R² = β₀ + β₁t + v_t, with t = 1 to 39 (corresponding to the 39 sample years 1975–2013). As a robustness check, we estimate a rank regression replacing the values of the dependent and independent variables with their ranks. The results from the two specifications are qualitatively similar.

Similar to past research on the change over time in the informativeness of accounting numbers, the above analyses are based on annual observations. The results obtained from the use of quarterly data for the full sample (not tabulated) are essentially the same. In particular, using a trend line over the 156 quarters, we find a significant upward trend over the time-series of quarters in the association of accounting information with bond valuation and returns, and a significant decline in the association of accounting information with equity valuation and returns. However, the level of association between accounting information and bond valuation and returns in any given period tends to be somewhat lower when estimated from quarterly data as compared with annual data.

Similar results are obtained using an alternative measure of default, Moody’s annual aggregated default rates.

Estimating regression (6) using a measure of NI that includes extraordinary items produces similar results.

Following Demerjian (2011), VRatio is defined as the ratio between Book Value Volatility and Adjusted Net Income Volatility. Book Value Volatility is the 5-year standard deviation of changes in retained earnings plus dividends. Adjusted Net Income Volatility is the 5-year standard deviation of net income minus special items and non-operating income and expenses. Assuming independence between the changes in core income and changes in AOCI, VRatio equals 1 + (variance of adjustments/variance of core net income).

This estimate assumes a steady state and straight-line amortization over a 5-year period. The resulting multiplier, 2.5, is based on the benefit period of R&D expenditures documented by Lev and Sougiannis (1996).

Cramer’s (1987) Z statistic is used to test the significance of the differences, with the standard deviation of the difference being estimated based on its large sample approximation, as developed by Olkin and Finn (1995). These statistics are also used by Harris et al. (1994) and Van der Meulen et al. (2007), among others.

As explained in Sect. 6.1, the default risk premium, a factor that does not appear in regression (7), could affect the relevance of accounting numbers to bond holders. When added as an independent variable to regression (7), the default risk premium (measured as the difference between the yields on Moody’s Baa and Aaa corporate bonds) has an insignificant coefficient and a minor effect on the slope coefficients of the other variables, and no effect on the statistical inferences.

The insignificant results from using the return models are likely to be related to the lower descriptive power of the bond return models as compared with the bond valuation models. The Adj. R _ACCT ² values for return models (5) and (10) are only 6.1 and 5.2 %, respectively, as compared with Adj. R² values of 24.0 % and 30.1 %, respectively, for valuation models (3) and (9). The low explanatory power of the return models suggests that important variables are omitted from these models. To the extent that these omitted variables are correlated with factors hypothesized to affect the information content of accounting numbers, the error in measuring the effects of these factors may be large.

The only exception is PROB, which has a negative (but insignificant) coefficient for model (3).

For example, the pairwise correlation coefficients computed over the 39 years between variables such as LOSS, NegCFO, and PROB range from 0.57 to 0.76.

The clearest manifestation of these increased disclosures is the expanded length of the 10-K over the examined period. A recent article in The Wall Street Journal (“The 109,894-Word Annual Report,” June 1, 2015) notes that the average number of words in a 10-K increased by 40 % from 1997 to 2014. To illustrate, the size of the General Motors’ 10-K file on the CAPITAL IQ database rose during that period from 0.5 MB to 46 MB. Similar findings on the steady increase in the length of the 10 K and, in particular, the MD&A and the notes sections, is provided by Li (2008).

See Alford et al. (1993), Francis and Schipper (1999), and Hanlon et al. (2005).

We use only 80 % of the observations (the extreme 40 % at either side of the expected return distribution) to render the results, comparable to the previous studies that use this approach to assess the information content of accounting numbers to equity holders. Use of the entire sample of firm-year observations leads to essentially the same results.

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Titel: The changing relevance of accounting information to debt holders over time
verfasst von: Dan Givoly
Carla Hayn
Sharon Katz
Publikationsdatum: 19.10.2016
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 1/2017
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-016-9374-y

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