Debt Analysts' Views of Debt-Equity Conflicts of Interest

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of debt analysts’ discussions reflects new information generated by analysts that expands the information set available to debt market investors. Our conflict-event discussion variable exhibits an incremental effect after controlling for firm-initiated disclosures and the disclosures of other intermediaries such as rating agencies and equity analysts. Second, we add to the small but growing literature on debt analysts. Although a vast number of studies investigate the activities of equity analysts or the use of their forecasts and recommendations, to date, limited evidence has been provided on the role of debt analysts. This is notable, given that the U.S. corporate debt market is the largest and most important source of capital for U.S. corporations. 3 Johnston et al. (2009), De Franco et al. (2009), and Gurun et al. (2011) find that bond and equity markets react to the publication of debt analysts’ reports and their recommendations and conclude that these intermediaries enhance the price discovery process. Our analyses complement these studies by providing insights into the type of information produced by debt analysts that explains the debt market’s reaction to these reports, beyond their recommendations. In addition, we provide new evidence on the relation between debt analysts’ reports and firms’ borrowing costs in the primary bond market. 4 Third, we provide and examine an empirical measure that captures debt holders concerns about wealth expropriation and asset substitution without the need to directly rely on bond returns around conflict events, as much of the prior literature does. Bond returns capture these concerns with significant measurement error caused by infrequent bond trading, divergent reactions due to different bond features, or reactions to firm fundamentals. Many conflict events 3 For example, according to Bessembinder and Maxwell (2008), for the decade ending in 2006, U.S. firms issued $4.6 trillion of corporate bonds, compared with $1.5 trillion of initial and seasoned public common equity. 4 To our knowledge, there is no work investigating the impact of debt analysts’ reports on firms’ bond yields or their cost of debt. Even prior work on the relation between equity analysts’ disclosures and firms’ debt costs is limited. Guntay and Hackbarth (2010) and Mansi et al. (2010) find that equity analysts’ forecast dispersion and forecast revision volatility increase bond yield spreads. 7
may also be anticipated by the market and therefore are not captured by short-window bond returns around the actual event. Further, with the exception of Parrino and Weisbach (1999), whose empirical analysis is limited to 23 firms, prior research on debt-equity conflicts has almost always focused on one particular type of conflict event in isolation, without assessing the interactions between conflict events and their simultaneous effect on debt holders’ wealth. This further contributes to the inconclusive evidence prior research provides with respect to the importance of conflicts to debt holders. 5 Our approach of coding the tone of debt analysts’ discussions about potential debt-equity conflicts allows us to document the importance of these conflicts as well as to determine whether and how debt holders’ wealth is affected. The next section develops our research question and reviews related literature on debt- equity conflicts. Section 3 describes our data and the measurement of debt analysts’ discussions of conflict events. Section 4 discusses the results of our tests. Section 5 concludes. 2. Literature review and research questions 2.1. Background on debt analysts 6 Most corporate bonds are traded in an opaque over-the-counter dealer market and often become absorbed in “buy-and-hold” portfolios shortly after issuance. Thus, the low ex-post and, in particular, ex-ante transparency of bond trading provides debt analysts with an opportunity to play a significant role in supporting the informational efficiency of the corporate debt market. Similar to equity analysts, debt analysts analyze firms’ fundamental performance and firm- 5 Prior studies also use very small samples, either because data on conflict events and bond prices has been difficult to collect or because of the infrequency of bond trading (Edwards, Harris, and Piwowar, 2006). 6 Part of this background information is based on our discussions with debt analysts and other debt market participants. In particular, we thank Richard Phelan, Managing Director of the European High Yield Research Team at Deutsche Bank and Peter Morris, formerly a sell-side debt analyst at Goldman Sachs and Managing Director in the European credit research team at Morgan Stanley. Also note that our study is about sell-side debt analysts, but for parsimony we refer to them simply as debt analysts. In this paper, we do not study buy-side debt analysts or analysts employed by credit rating agencies. 8
Page 1 and 2: Debt Analysts’ Views of Debt-Equi
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Page 5 and 6: these conflict events, highlighting
Page 7: investors are more sensitive to new
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 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
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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
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TABLE 5 The effect of the tone of d
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