Debt Analysts' Views of Debt-Equity Conflicts of Interest

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sinking fund provisions, etc.). Hence if, for example, analysts were to issue a negative view of a conflict event, they may perceive these protective features as insufficient. On one hand, because debt-equity conflicts have the potential to meaningfully affect debt holders’ wealth, we expect debt holders to demand information on these events and for debt analysts to meet this demand. If the potential conflict is material, whether or not it has been anticipated, debt analysts are likely to monitor, analyze, and discuss its effect on the value of outstanding debt securities in their reports. In particular, we expect conflict discussions to distinguish debt analysts’ from equity analysts’ reports. If the contents of the former were limited only to an analysis of a firm’s fundamentals, such as the level of EBITDA or earnings, the distinction between equity and debt analysts’ reports would be blurred because we would expect both types of analysts to monitor and evaluate the firm’s performance. Therefore, our prediction is that the tone of debt analysts’ conflict discussions is relevant for debt investors and generates debt market reactions. Given the payoff function of debt securities, which are fixed claims against the borrowing firm and have limited upside potential, we expect debt holders to have an asymmetric demand for negative information. As a result, we predict that debt market reactions will be stronger if debt analysts have negative views about conflict events. Empirically, we measure debt market reactions by changes in secondary market CDS spreads and bond trading volume and by the level of bonds’ yield to maturity on new bond issues in the primary market. Our primary market setting reinforces the economic importance of conflict discussions because yields on new issues represent real effects on a company’s cost of debt financing. On the other hand, the extent and economic importance of such conflicts to debt holders, as documented by extant studies, is far from clear. Parrino and Weisbach (1999), discussed above, is one example. In the case of spin-offs, Hite and Owers (1983) and Schipper and Smith (1983) 11
find no evidence of a wealth transfer at the time of the announcement, while Maxwell and Rao (2003) document a wealth transfer from debt holders to equity holders. With respect to cash payouts, Woolridge (1983), Handjinicolaou and Kalay (1984), and Dann (1981) do not find that dividend payments have a detrimental effect on bondholders. In contrast, Dhillon and Johnson (1994) and Maxwell and Stephens (2003) find evidence supporting a wealth transfer from debtholders for large dividend changes and share repurchases, respectively. Finally, while, Asquith and Wizman (1990), Warga and Welch (1993) and Billett, King, and Mauer (2004) document a loss in debt holders’ wealth associated with leveraged buyouts and acquisitions, Lehn and Poulsen (1991) and Marais, Schipper, and Smith (1989) find that leveraged buyouts do not result in a wealth transfer. If conflicts events are not material or have a minimal effect on debt holders’ wealth, as suggested by some of these studies, the debt market should not react to the tone of debt analysts’ conflict discussions. Similarly, the debt market should not react to the tone of debt analysts’ conflict discussions if they do not provide valuable new information to debt investors or are not timely. Across all three market settings – CDS spreads, bond trading volume, and new bond issues’ yield to maturity – we expect the importance of conflict discussions to vary cross-sectionally with firms’ debt rating. For higher quality debt, debt prices are less sensitive to new information, either because the likelihood of a loss is very small or because the upside potential is already limited. In contrast, for lower quality debt, bond prices are highly sensitive to information (De Franco et al., 2009; Easton et al., 2009), making the news provided by debt analysts’ conflict discussions more valuable to debt investors. Based on this argument, we predict that the tone of debt analysts’ conflict discussions leads to greater market reactions for lower rated debt. However, there is some merit in the opposite prediction as well. If bond investors’ 12
Page 1 and 2: Debt Analysts’ Views of Debt-Equi
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Page 5 and 6: these conflict events, highlighting
Page 7 and 8: investors are more sensitive to new
Page 9 and 10: may also be anticipated by the mark
Page 11: compliance department. 7 The value
Page 15 and 16: Investment Trusts; on financial ins
Page 17 and 18: manual coding (positive, neutral, o
Page 19 and 20: match the debt analysts’ report d
Page 21 and 22: of the operating fundamentals’ st
Page 23 and 24: ecommendation level is a sell, hold
Page 25 and 26: ecommendations. In terms of economi
Page 27 and 28: equity holders, as evidenced by pos
Page 29 and 30: incremental to the effect of their
Page 31 and 32: conflict events (with conflict even
Page 33 and 34: conflict discussions that are longe
Page 35 and 36: et al. (2009). As expected, credit
Page 37 and 38: of debt analysts’ conflict discus
Page 39 and 40: (0.02). These results are consisten
Page 41 and 42: We identify a sample of equity anal
Page 43 and 44: eaction tests, using Alternative Me
Page 45 and 46: References Acharya, V., and T. John
Page 47 and 48: Handjinicolaou, G., and A. Kalay. 1
Page 49 and 50: Variable Definition APPENDIX 1 Vari
Page 51 and 52: Variable Definition Debt Recommenda
Page 53 and 54: APPENDIX 2 Examples of text extract
Page 55 and 56: TABLE 1 Accuracy of Naïve Bayes cl
Page 57 and 58: TABLE 3 Analysis by conflict event
Page 59 and 60: TABLE 5 The effect of the tone of d
Page 61 and 62: TABLE 7 The effect of the tone of d
Page 63 and 64:
TABLE 8 The effect of the tone of d
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Debt Analysts' Views of Debt-Equity Conflicts of Interest

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