Debt Analysts' Views of Debt-Equity Conflicts of Interest

Debt Analysts’ Views of Debt-Equity Conflicts of Interest
1. Introduction
Recent studies such as Johnston, Markov, and Ramnath (2008), De Franco, Vasvari, and
Wittenberg-Moerman (2009), and Gurun, Johnston, and Markov (2011) show that investors react
to the publication of debt analysts’ reports and the recommendations they provide, suggesting
that debt analysts act as important information intermediaries in debt markets. Besides providing
a review of firms’ financial performance in their reports, debt analysts analyze and discuss the
effects of debt-equity conflict events that potentially generate asset substitution and wealth
expropriation by equity holders, such as M&A transactions, additional borrowings, share
repurchases, and excessive dividend payments (hereafter, we refer to these as “conflict events”).
This study documents the importance of debt analysts’ discussions about conflict events by
investigating how credit markets react to the tone of these discussions via changes in credit
spreads and bond trading volume. We further test whether analysts’ views about conflict events
are associated with real effects on a company’s cost of debt, as evidenced by analysts’ ability to
predict the yield to maturity of new bond issues.
While previous studies have established the existence of events that lead to debt-equity
conflicts in specific settings, these studies find mixed results with respect to the extent and
economic importance of such conflicts to debt holders. 1 If these conflict events have the potential
to meaningfully affect debt holders’ wealth, debt analysts’ discussions can be informative to debt
investors. However, if the effect of conflict discussions about outstanding debt securities is not
material or if debt analysts’ conflict event discussions do not provide valuable new information
1 For example, see Schipper and Smith (1983), Parrino and Weisbach (1999), Maxwell and Rao (2003), Woolridge
(1983), Dhillon and Johnson (1994), and Maxwell and Stephens (2003). We discuss these papers and others in detail
in Section 2.2.
2