Debt Analysts' Views of Debt-Equity Conflicts of Interest

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or are not timely, these discussions will not expand the information set available to debt market investors. The centerpiece of our empirical analysis is the coding of the tone of debt analysts’ discussions about conflict events as published in their investment reports. We expect that reports provided by debt analysts will allow us to better assess the impact of conflict events on debt holders’ wealth, given debt analysts’ primary purpose of informing debt investors. We measure the extent and tone of debt analysts’ discussions about different types of conflict events using a unique hand-collected dataset of 11,025 sell-side debt analysts’ reports on U.S. firms. Specifically, from each debt analyst’s report we extract the text around a comprehensive list of keywords associated with events such as M&A transactions, divestments, dividend payments, stock repurchases or borrowing (e.g., “M&A”, “repurchases”, “asset sales”, “dividends”, etc.). We then manually code a large randomly selected subset of these text extractions and use it to calibrate a Naïve-Bayesian model that predicts whether the analyst’s discussion is negative, neutral, or positive. In the last step, we use this model to produce a predicted tone for the full sample of text extractions used in our tests. We document that debt analysts routinely discuss events that are likely to generate debt- equity conflicts in their reports. M&A activities are frequently discussed events, with 63% of the debt analysts’ reports mentioning such transactions. In 32% of the reports, analysts talk about potential wealth redistribution from debt to equity holders via stock repurchases or dividend payments. Divestment discussions characterize about 18% of the reports. Matters of financial risk and borrowing, a comprehensive category that includes discussions about “debt” and “leverage”, comprise the most frequently discussed subject (91% of the reports). We also find that debt analysts’ conflict discussions not only follow but also anticipate firm announcements of 3
these conflict events, highlighting their informativeness. While debt analysts are more likely to interpret the conflict events for debt investors as positive (24% of reports) compared with negative (17% of reports), in most cases (59%) these events are interpreted as mixed or neutral news for debt investors. This finding suggests that conflict events are not always expected to destroy debt holders’ wealth. Instead, these events can provide a positive signal regarding a firm’s performance, represent news that is less negative than debt holders initially expected or simply not material. We next find that the tone of debt analysts’ conflict discussions is positively related to analysts’ investment recommendations and recommendation revisions, the main summary outputs of their reports. These relations provide additional support for the notion that the tone of debt analysts’ conflict discussions is likely informative to debt market participants. Further, the tone of the conflict discussions helps to explain disagreement between the recommendations of debt and equity analysts, consistent with the tone indicating potential wealth expropriation concerns. Turning to our debt market tests, we first find that debt analysts’ reports are more relevant to debt investors, as evidenced by stronger debt market reactions, when the reports contain negative discussions of debt-equity conflicts. After controlling for a wide range of economic factors that affect CDS spreads, we document that firms’ credit default swap (CDS) spread changes are significantly increasing in debt analysts’ negative discussion of conflict generating events. Relative to reports with positive or neutral discussions, reports that include negative discussions increase the CDS spread by 16 basis points over a five-day window centered on the date of debt analysts’ report. In particular, we show that when equity investors’ wealth improves, as evidenced by positive equity returns, analysts’ negative discussions of 4
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Page 7 and 8: investors are more sensitive to new
Page 9 and 10: may also be anticipated by the mark
Page 11 and 12: compliance department. 7 The value
Page 13 and 14: find no evidence of a wealth transf
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Page 19 and 20: match the debt analysts’ report d
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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
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TABLE 1 Accuracy of Naïve Bayes cl
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TABLE 3 Analysis by conflict event
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TABLE 5 The effect of the tone of d
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Debt Analysts' Views of Debt-Equity Conflicts of Interest

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