Externalities of Credit Default Swaps on Corporate ... · 1 1 Introduction In this study, we...
Transcript of Externalities of Credit Default Swaps on Corporate ... · 1 1 Introduction In this study, we...
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Externalities of Credit Default Swaps on Corporate Disclosure
Matthew Cedergren [email protected] University of Pennsylvania Philadelphia, Pennsylvania
Ting Luo [email protected]
Tsinghua University Beijing, China
Yue Zhang [email protected]
Lingnan University Hong Kong, China
April, 2018
Abstract
We investigate the effects of credit default swap (CDS) trading on customer firms on management forecasts by the supplier firms. We find that firms which derive a greater proportion of their revenue from CDS-referenced customers tend to lower forecast issuance, suggesting that enhanced information revelation in customers’ CDS market decreases suppliers’ disclosure benefits, creating a disincentive for managers to issue forecasts. We further find that this effect manifests for good news forecasts, but not for bad news forecasts, because of the litigation risk associated with withholding bad news. Our results are robust to a variety of sensitivity tests that control for potential self-selection in CDS-referenced customers, and our results strengthen when we focus on supplier firms which themselves are not referenced by CDSs. Our findings add to the literature examining the externality effects of CDSs on corporate decisions of entities outside of those directly referenced by CDSs.
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1 Introduction
In this study, we examine whether credit default swap (CDS) trading on a firm's major
customers influences the corporate disclosure policy of the supplier firms. The development of
the CDS market has been one of the most significant financial market developments in recent
years, with the notional amount of underlying CDS-referenced instruments growing from $918
billion in 2001, to an all time high of $62.2 trillion at the end of 2007.1 Although the CDS
market has contracted since the 2008 financial crisis, the size of the market, in terms of notional
amounts upon which CDSs have been written, remained above $10 trillion at the end of 2015.
Meanwhile, CDSs continue to be a primary mechanism through which financial institutions
manage and distribute risk to other parties. The CDS market has been shown to impact the
information environment and corporate policies of the firms that CDSs are traded on. For
example, CDS trading reduces analyst forecast errors (Eli Batta et al. 2016), increases dividend
payout to equity holders (Landsman et al. 2017), and increases management forecast activity of
the reference firms (Kim et al. 2017a).
One concern on CDSs is that they generally trade on larger firms, making it difficult to
generalize the documented effects of CDS trading to other entities of smaller size. A recent
study of Li and Tang (2016) has tried to address this issue by investigating whether the effects of
CDS trading extend to the reference firms’ supply chain partners. Taking advantage of SFAS
131, which requires firms to disclose the identity of major customers, Li and Tang find that CDS
trading on major customers has externality effects that improve the information environment of
the supplier firms, reducing equity issuance costs and leading to lower leverage.
We examine whether externality effects of CDSs apply to the realm of corporate
disclosure. It has been well established in the literature that disclosure is linked to other channels 1 International Swaps and Dealers Association 2010 Market Survey.
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of information in the market, affecting them and being affected by them in turn (Einhorn 2017).
CDS trading facilitates information production regarding the firms referenced by the CDS
instrument, because of informed trading in the CDS market (Li and Tang 2016) and increased
disclosure by the reference firms (Kim et al. 2017a). Given that revealed information and
promoted disclosure can also reflect the performance of firms having substantive economic ties
to the firm directly referenced by the CDS instrument, CDS trading provides an additional
information source regarding these economically connected firms. This will affect connected
firms’ disclosure behavior because: (1) additional information serves to reduce information
asymmetry of these firms; (2) the presence of alternative information sources generates an
opportunity cost for disclosure in that such alternative information may provide a more favorable
picture of the firm than does the information disclosed by the firm itself (Einhorn 2017).
Reduced information asymmetry and increased disclosure cost create a disincentive for the
linked firms to supply voluntary disclosure.
We follow Li and Tang (2016) and choose supply chain partnership as the setting to
examine CDSs’ externality effects on corporate disclosure. Particularly, we investigate how a
firm’s forecast behavior changes in response to varying levels of sales to CDS-referenced
customers. When firms make more sales to CDS-referenced customers, they have a closer
economic relationship with these customers, and information created by customers’ CDS trading
can better reflect (and is more useful in evaluating) the performance of the supplier firms. As
such, we expect higher sales to CDS-referenced customers leads to lower demand for the firms’
voluntary disclosure and thus less frequent issuance of management forecasts. We assemble a
sample of 10,865 firm-year observations, representing 2,433 unique firms, both with and without
sales to CDS-referenced customers, spanning the period from 2002 through 2012. We conduct
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our tests using ordinary least squares (OLS) and logistic regressions—depending on whether the
dependent variable is forecast frequency or forecast likelihood—that control for firm and time
fixed effects. We find that firms decrease their overall level of management forecast activity
when a greater proportion of their revenue is derived from CDS-referenced customers. This
evidence is supportive for CDS market’s externalities on corporate disclosure policy.
We next explore whether customers’ CDS trading influences the nature of the news
conveyed through the supplier firms’ management forecasts. We argue that the overall
externality effect documented above is mainly driven by good news forecasts rather than bad
news forecasts, because sales to CDS-referenced customers generate two countervailing
incentives on bad news disclosure. On one hand, the alternative information source, generated by
informed trading in the CDS market and promoted disclosure from the reference customers,
decreases information asymmetry and increases disclosure cost with regard to bad news for a
major customer, as discussed above. This information effect will spill over to a supplier which
derives a significant portion of its business from the customer, leading to less of a need for the
supplier firm in terms of bad news disclosure. In other words, there is less frequent issuance of
bad news management forecasts from firms having more revenue derived from CDS-referenced
customers.
On the other hand, withholding bad news is subject to litigation risk (Skinner 1994). Such
litigation risk can be higher when customers are CDS-referenced because the enhanced
production of information may raise the concern that managers have private information that is
not disclosed to the public. The threat of litigation associated with not disclosing bad news would
induce the firms with more revenue derived from CDS-referenced customers to increase bad
news forecasts. Therefore, the information effect and litigation effect acts as countervailing
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forces with regards to bad news forecasts. This is what we find in our tests: the overall negative
relation between management forecasts and sales to CDS-referenced customers is driven by good
news forecasts, while bad news forecasts do not show this pattern.
To alleviate potential concern on self-selection in the supplier-customer relationship, we
perform a difference-in-differences analysis by identifying a treatment group of supplier firms
which make sales to a CDS customer for the first time over a four-year window. We then
measure the change in forecast issuance from the last two years of the window (in which
treatment firms have sales to CDS-referenced customers) to the first two years of the window
(where treatment firms do not have such sales) and compare this change to a matched control
group of firms which do not have any sales to CDS-referenced customers during the same four-
year window. We also perform an instrumental variable approach where customers’ CDS status
is instrumented by the average bond trading volume of customers’ industry peers, proxied for
bond investors’ hedging and speculative demand in the CDS market. We find that our main
results hold in each of these analyses.
Expanding our analyses, we then explore the role of litigation risk and its influence on the
relation between management forecasts and sales to CDS-referenced customers. Using a
measure of ex ante litigation risk developed by Kim and Skinner (2012), we find that increased
litigation risk does not significantly influence the relation between good news forecasts and sales
to CDS-referenced customers. However, we find a significantly positive impact for bad news
forecasts, suggesting that litigation risk restricts the externalities of the information effect of
CDSs on suppliers’ bad news forecasts.
Finally, we conduct a variety of robustness tests to enrich our analyses. Notably, we
focus on supplier firms that are themselves not CDS-referenced, as the CDS trading on their
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customers is likely to be more incrementally informative with regards to these firms. The results
strengthen when we exclude CDS-referenced supplier firms.
Our study contributes to the growing literature examining the impact of financial
innovations on corporate policies. We expand upon Li and Tang's (2016) study examining the
externality effects that CDSs have along the supply chain. Li and Tang find that greater
information availability through customers’ CDS referencing influences a firm' financing policy,
and we extend the externality of CDSs to disclosure behavior. The externality on disclosure
policy, together with that documented in Li and Tang, suggests that although CDSs exist only for
a handful of large firms, their effects are not confined to the reference firms; rather, the effects
can extend to economically linked entities as well.
Our study also contributes to the literature of corporate disclosure by documenting that
peer firm financial market innovation in the form of CDS trading is an important influence on the
decision to issue management forecasts. Note that CDSs can exercise different effects on
disclosure activity of the reference firms themselves versus their peers. First, managers of the
reference firms are insiders and are believed to be more informed than external peers. If
information is revealed through the CDS market instead of through firm disclosure, managers of
the reference firms are very likely to be challenged or even sued for hiding information. In
contrast, peer firms such as supplier firms are outsiders. They are not necessarily exposed to the
same litigation risk as the reference firms in this regard. Second, the CDS market reduces
lenders’ monitoring on the reference firms, but does not yield the same effect on their peer firms,
which may motivate different disclosure responses from the reference firms and peers. Indeed,
what we find is a decreased propensity for management forecasts from the reference entities’
suppliers, rather than an increased propensity for forecasts from the reference entities as in Kim
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et al. (2017a). Therefore, the peer effect as examined in this study and the direct effect on the
reference firms themselves as examined in Kim et al. together provide a more comprehensive
understanding of the impact of CDSs on corporate disclosure.
Another stream of research studies peer effects in various corporate decisions, such as
capital structure choice (Leary and Roberts 2014), financial misconduct (Kedia et al. 2015) and
executive compensation (Shue 2013). Our study adds to this line of research by providing
evidence on the peer effect in corporate disclosure decisions.
The rest of the study proceeds as follows. Section 2 discusses related literature and
develops hypotheses. Section 3 describes the sample selection and presents descriptive statistics.
Section 4 presents research design, empirical results and robustness tests, and Section 5
concludes the study.
2 Related literature and hypotheses
2.1 Information environment and the CDS market
In a typical CDS contract, the buyer of credit risk protection transfers the risk to the
seller. The reference entity is not a party to the contract. When the reference entity experiences a
credit event such as default, the seller compensates the buyer for the loss either by the buyer
physically delivering the defaulted debt to the seller and receiving payment of par value from the
seller, or by auction where the buyer receives the auction proceeds and the seller pays the buyer
the cash difference between par value and auction proceeds (Griffin 2014).
Given its dramatic growth in recent years, the CDS market has become an increasingly
important area of academic study.2 A number of studies investigate how CDS trading affects the
information environments of firms. Banks, mutual funds and hedge funds are influential players 2 More thorough reviews of the CDS literature can be found in Augustin et al. (2014) and Augustin et al. (2016).
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in the CDS market. They often have access to non-public information about the reference firms
through lending activities or tight connections with large financial institutions (Acharya and
Johnson 2007). CDS trading and price discovery are able to facilitate information production
regarding the reference firms. For example, Acharya and Johnson find evidence of significant
incremental information revelation in the CDS market by informed banks. Similarly, Eli Batta et
al. (2016) document that the effect of CDSs’ price discovery prior to earnings announcements is
related to the presence of private information, and the CDS market conveys information valuable
to financial analysts. Zhang and Zhang (2013) find that the CDS market anticipates earnings
surprises up to a month in advance of the earnings announcement. Besides facilitating revelation
of performance information, the CDS market is also informative about the reference firms’
information quality. Ertan et al. (2016) show that CDS term structure signals the reference firms’
likelihood of earnings management. Griffin (2014) reports that the quality of financial
information affects CDS spreads, and Tang and Yan (2015) find that companies experiencing
material weaknesses in internal control exhibit higher CDS spreads than companies with
effective internal control.
Other studies show that CDS trading can influence corporate decisions of the reference
firms. Saretto and Tookes (2013) find that firms with traded CDS contracts maintain higher
leverage ratios and longer debt maturities because CDSs alleviate frictions on the supply side of
credit market. Meanwhile, Landsman et al. (2017) find that following CDS trading initiation,
reference firms increase dividend payouts to mitigate the agency conflicts between managers and
equity holders that arise because of lowered incentives of banks to monitor firms with CDS
trading. Kim et al. (2017b) find that introduction of CDSs increases creditors’ tolerance for tax
avoidance, and borrowing firms significantly increase their level of tax avoidance when they
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have CDS trading on their debts. From an accounting perspective, Gong et al. (2015)
hypothesize that CDS trading reduces lenders' incentives to monitor borrowers and reduces
demand for conservative reporting. They find that borrowing firms' reporting conservatism
indeed declines following the initiation of CDS trading. Kim et al. (2017a) find that intensified
shareholders’ monitoring when CDSs are actively traded makes managers at the reference firms
more likely to issue management forecasts.
2.2 Information externality effects
Many studies examine information externalities using the setting of the supply chain.
Information from a supply chain partner is value-relevant because it helps investors revise
expectations about future cash flows, reduces uncertainty about those cash flows, or both (Pandit
et al. 2011). Olsen and Dietrich (1985) were the first to examine information transfers along the
supply chain. They demonstrate that supplier firms’ stock prices react to the monthly sales
announcements of their major customers.
Along this line, some recent studies examine how supplier firms react to the earnings-
related information of major customers. For example, Pandit et al. (2011) find that supplier firms
have a stronger return reaction to the quarterly earnings announcements of their major customers
when the economic link between the suppliers and the customers is stronger. Using a similar
setting, Cheng and Eshlman (2014) find that shareholders are less likely to overreact (in terms of
price reaction by the supplier firm) to a customer’s earnings announcements when the customer
accounts for a larger percentage of the supplier firm's revenue. Ma (2017) tests the theoretical
framework of Lambert et al. (2007) and finds that higher earnings quality of economically linked
firms reduces firms’ systematic market risk. Radhakrishnan et al. (2014) find a positive
association between suppliers’ operating performance and greater provision of earnings forecasts
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by major customers. Other studies focus on non-earnings information and find that this type of
information also affects supplier firms. For example, Fee and Thomas (2004) find that suppliers
experience significant abnormal returns to customers’ horizontal merger announcements. Hertzel
et al. (2008) find that pre-filing and filing of bankruptcy are associated with a significantly
negative stock price reaction of suppliers.
The externality effect of information regarding customers is not only limited to suppliers
and their investors, but also applies to other parties. Guan et al. (2015) and Luo and Nagarajan
(2011) find that when analysts cover firms along a supply chain, their forecast accuracy
improves and is superior to forecasts of firms outside the supply chain. Johnstone et al. (2014)
find that auditors’ supply chain knowledge shared at the local-office level is associated with
higher audit production efficiencies, resulting in higher audit quality and lower audit fees for the
suppliers. Gong and Luo (2014) examine the value of supply-chain information in lenders’
decision making and find that through pre-existing lending relationships with major customers,
lenders tend to reduce their reliance on suppliers’ conservative accounting. Cen et al. (2016) find
that supplier firms having a longer relationship with major customers are perceived as “safer”
firms by banks, and thus enjoy smaller loan spreads and looser loan covenants.
Most relevant to our study, recently Li and Tang (2016) examine the externality effects of
CDS trading along the supply chain. They argue and find that customers’ CDS trading acts as a
vehicle for improved price discovery and thus reduces information asymmetry of the supplier
firms. This in turn reduces suppliers’ equity costs, facilitates equity issuance, and reduces
leverage.
2.3 Hypothesis development
We extend Li and Tang's research by investigating whether and how these CDS
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externality effects extend to voluntary disclosure decisions. It is well-established in the
disclosure literature that disclosing forward-looking news involves various costs and benefits.
Managers have to trade off costs and benefits in determining their disclosure policy (e.g.,
Verrecchia 2001; Cheng and Lo 2006). If customers’ CDS trading can affect costs and benefits
associated with disclosure for supplier firms, we would expect suppliers’ forecast behavior to
vary with changes in the level of sales to CDS-referenced customers.
CDS trading can facilitate information production on the firms referenced by the CDS
instrument. First, traders on the CDS market very often have non-public information about the
reference firms and such information is revealed to the public through informed traders’ trading.
As documented in Acharya and Johnson (2007), information possessed by loan officers is
transmitted to the market as they trade in the CDS market. Second, CDSs can promote more
voluntary disclosure from the reference customers. The effect of CDSs is to mitigate lenders’
risk exposure and weaken their incentives to monitor borrowers, i.e., the reference firms. This
leads to intensified monitoring from shareholders that have higher demand for voluntary
disclosure. Consistent with this view, Kim et al. (2017a) find that managers are more likely to
issue earnings forecasts when firms have actively traded CDSs.
Because of the close economic link between customers and their suppliers, customers’
information can partly reflect supplier performance. Therefore, enhanced information flow about
the reference customers can provide an additional public information source for investors of the
supplier firms and help such investors more efficiently evaluate the supplier firms’ future
prospects. The presence of additional information reduces the benefits of disclosure and
generates disincentives for suppliers to issue management forecasts for the following reasons.
First, the additional information reduces the overall level of information asymmetry of
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the supplier firms. Theoretical models such as Diamond (1985) imply that managers may commit
to disclose more information than is mandated in order to reduce information asymmetry.
Consistent evidence is also provided in the survey study by Graham et al. (2005). As in the
context of management forecasts, the supply and demand of forecasts have been documented to
be driven by information asymmetry, with managers issuing forecasts to reduce the asymmetry
in information between managers and outside investors (Verrecchia 2001). Coller and Yohn
(1997) find that firms issuing management forecasts tend to have higher levels of information
asymmetry. In a recent study by Balakrishnan et al. (2014), the authors use plausible exogenous
variation in the supply of public information to show that firms actively shape their information
environment by voluntarily issuing more management forecasts. With the information
asymmetry reduction brought about by the development of customers’ CDS market, there are
less benefits of disclosure for supplier firms, which in turn reduces the issuance of management
forecasts.
Second, additional information associated with customers’ CDS trading increases the
disclosure cost for supplier firms. The recent theoretical paper by Einhorn (2017) develops a
framework with the presence of competing information sources for corporate disclosure. Under
this framework, there is an opportunity cost for disclosure in that managers lose the opportunity
that the additional information may be more favorable than the disclosed information, in which
case withholding of disclosure would be a more optimal strategy. Einhorn documents that
managers would be willing to refrain disclosure to gamble on the unknown content of
forthcoming information. This is primarily the same case as when suppliers face more
information produced through their customers’ CDS market. The higher disclosure cost makes
suppliers less likely to issue management forecasts.
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We expect that these impacts are stronger for the suppliers that are more closely
connected with the reference customers. When a firm makes more sales to CDS-referenced
customers, it has a closer economic relationship with these customers and information created by
customers’ CDS trading can better reflect its performance. Therefore, the information effect
would be more pronounced for these firms. As such, our first hypothesis is stated formally as:
H1: Ceteris paribus, firms with higher sales to CDS-referenced customers are less likely
to issue management forecasts, compared to other firms.
We further argue that customers’ CDS trading differentially influences the issuance of
good news and bad news management forecasts of the supplier firms, because CDSs generate
two countervailing incentives for bad news forecasts, but not so for good news forecasts. As
discussed above, informed trading in the CDS market and promoted disclosure from the
reference customers produce more information, including bad news, to the public. With more
timely revelation and more production of bad news regarding customers, the supplier firms’
information asymmetry and disclosure cost in terms of bad news change significantly, and
incentives for the supplier firms to release bad news forecasts are mitigated. Hence, the
information effect predicts a negative relation between sales to CDS-referenced customers and
issuance of bad news management forecasts.
On the other hand, withholding bad news is subject to litigation risk (Skinner 1994). With
more negative information being revealed in customers’ CDS market, investors are more likely
to suspect supplier firms may have private information. Suppliers would be exposed to higher
litigation threats resulting from accusations that management was hiding bad news. This will
discipline managers of the firms with more revenue derived from CDS-referenced customers to
increase bad news forecasts. The above discussion suggests that the two incentives resulting
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from information effect and litigation risk generated by customers’ CDS trading would act as
countervailing forces for bad news forecasts. However, for good news forecasts, information
incentive would dominate, as there is less litigation risk associated with delayed disclosure of
good news. Thus, our hypothesis is directional for good news forecasts and non-directional for
bad news forecasts.
H2a: Ceteris paribus, firms with higher sales to CDS-referenced customers are less likely
to issue good news management forecasts, compared to other firms.
H2b: Ceteris paribus, firms with higher sales to CDS-referenced customers do not differ
in the issuance of bad news management forecasts, compared to other firms.
3 Data and sample
3.1 Sample construction
We construct a sample of firm-years using the intersection of several databases. We
obtain data on credit default swaps from the Markit database. For a given reference entity,
Markit contains information on the existence of CDS contracts, liquidity measures, and spreads.
We obtain information on supplier-customer relationships from the Compustat Segments
database. Statement of Financial Accounting Standards No. 131, Disclosures about Segments of
an Enterprise and Related Information, which became effective for fiscal years beginning after
December 15, 1997, requires firms to separately disclose the identity and amount of sales
revenue derived from any individual customer accounting for 10% or more of the supplier firm's
total sales revenue.3 We then link the CDS-referenced firms with the customers identified in the
Compustat Segments database to determine the percentage of each supplier firm's sales to
3 The provisions of SFAS 131 are now largely contained in Section 280 of the FASB's Accounting Standards Codification (ASC).
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customers with CDS contracts being traded.4
We obtain firm-year level accounting data from the Compustat Fundamentals Annual
database. Because the Compustat Segments file provides only the customer name reported by the
firm, we manually match identified customers where appropriate to the corresponding gvkey
identifier in Compustat. We obtain daily return data from the Center for Research on Security
Prices (CRSP), and analyst forecast data from I/B/E/S. For management forecasts, we utilize the
I/B/E/S management guidance database. When a firm reports more than one CDS-referenced
customer in one year, we aggregate customer data for each supplier year. Our empirical analyses
are on firm-year basis.
Table 1 Panel A outlines our sample selection criteria and composition. After obtaining
firm-year observations with available CDS data in the Markit database, and after linking the
CDS reference entities with the Compustat customer segments database and retaining those
observations with available data from the other above mentioned databases, we arrive at a final
sample of 10,865 firm-year observations, representing 2,438 unique firms, over the period from
2002 through 2012. Of these firm-years, slightly more than half (5,437 firm-years, representing
1,758 unique firms) are firm-years in which the firms had positive sales to CDS-referenced
customers.
Panel B of Table 1 provides a year-by-year breakdown of the supplier firms and CDS-
referenced customers in our sample. Typically, a firm discloses sales about two major customers,
with sales to major disclosed customers accounting for 33.9% of total sales.5 In most years there
are typically slightly more than one thousand unique customer firms which have active CDS 4 It is possible that firms have sales to CDS-referenced customers not disclosed by the firms because such sales constitute less than 10% of the firms’ total revenue. Thus, this figure represents a lower bound on the percentage of sales made to CDS-referenced customers. 5 Since our measure of sales to CDS-referenced customers relies on customer identification, each firm-year in the sample must have at least one disclosed customer. In our sample, 49.4% of firm-years disclose one customer, 24.1% of firm-years disclose two, 12.5% disclose three, and 6.3% disclose four or more.
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trading and for which we are able to match to our sample of supplier firms. As mentioned above,
more than half of all firm-years in our sample have positive sales to CDS-referenced customers,
and this pattern generally holds on a year-to-year basis.
3.2 Descriptive statistics
Panel A of Table 2 presents descriptive statistics for variables of interest in our study, as
well as control variables. Consistent with Li and Tang (2016), we use a firm's sales to disclosed
CDS-referenced customers to measure the firm's overall exposure to CDS-referenced customers.
Specifically, we measure the firm's exposure to CDS-referenced customers in a given year as the
sales to customers with CDS trading in the current year, divided by the firm's total sales for that
year. In our sample, 5,437, or 50.3%, of firm-years (representing 1,758, or 72.3%, of all firms)
have positive sales to CDS-referenced customers. The overall mean percentage of sales to CDS-
referenced customers is 19.2% (among firm-years with positive sales to CDS-referenced
customers, this mean is 28.9%). There is considerable cross-sectional variation in this figure,
ranging from 12.6% at the overall median, to 68.0% at the 95th percentile.
Our dependent variable is voluntary disclosure in the form of management earnings
forecasts. We employ two measures of management forecasts. First, we define the variable
(MF_N) as the number of instances of management earnings forecasts provided in a given firm-
year. This variable has an overall mean value of 1.956 (among firm-years with management
guidance activity during the year, this mean value is 5.713). Second, we use an indicator variable
(MF_D) taking a value of one if the firm issues at least one earnings forecast during the fiscal
year, and zero otherwise. This variable has a mean value of 0.342, indicating that slightly over
one-third of our firm-years have management guidance activity.
We additionally classify management forecasts into good news and bad news forecasts.
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As discussed earlier, we utilize the I/B/E/S management guidance database. I/B/E/S classifies
management forecasts as good or bad based on a comparison of the forecasted earnings amount
to the consensus analyst forecast as the time of issuance.6 In our sample, 23.8% of firm-years
have good news forecasts, with a mean frequency of 0.632, while 28.4% of firm-years have bad
news forecasts, with an average frequency of 0.945.
The median firm-year has four analysts covering (with 72.7% of all firm-years having at
least one analyst covering), market capitalization of $335 million, and a market-to-book ratio of
1.962. In terms of operating performance, the median firm-year has return on assets (ROA) of
2.6%, and 38.7% of the firm-years in our sample have loss. The return patterns in our sample
show considerable variation, with the middle 50% of firm-year returns ranging from −24.2% to
+27.3%, and daily volatility ranging from 2.32% to 4.17%.
Panel B of Table 2 displays univariate correlations among our control variables, and
primary independent variables of interest, customer CDS sales. We find that customer CDS sales
is not significantly correlated with our control variables. Other correlations are usually not large
except that between return on assets and loss (−0.633) which is reasonable considering the
mechanical relation between these two variables.
4 Empirical results
4.1 Customer CDS trading and management forecast activity
In our initial analyses, we examine the relation between the likelihood and frequency of
management forecasts during the fiscal year and the extent to which CDSs are actively traded on
6 In untabulated analyses, we manually classify a management forecast as good (bad) news if the point estimate, or the mid-point of the range forecast, is above (below) the average of analyst forecasts issued in the 90 days before the management forecast. For open-ended management forecasts, the forecast is classified as good (bad) news when its bottom (upper) bound is higher (lower) than average analyst forecast. The main results hold.
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the firm's major customers. In our main tests, we regress management forecast issuance on sales
to CDS-referenced customers and a set of firm controls, along with firm and year fixed effects:
εeffectsfixedyearandFirmcontrolsFirmβ
SalesCDSββMF_N(MF_D)
i
10 (1)
Management forecast issuance is represented by either the frequency variable of MF_N
or the indicator variable of MF_D(as described earlier). Equation (1) takes the form of an
ordinary least squares (OLS) model when the dependent variable is MF_N, and of a logistic
model when the dependent variable is MF_D. Our main variable of interest is CDS Sales, which
is the percentage of the firm's sales during the fiscal year that went to customers with CDS
trading during that year. Following prior research (Rogers and Van Buskirk 2009; Chen et al.
2011), we control for other known determinants of management forecasts, including analyst
following, firm size (as measured by market capitalization), market-to-book ratio, return
volatility (measured as the standard deviation of daily returns), operating performance (measured
by return on assets, as well as a loss indicator variable), and stock return. All balance-sheet
variables are measured at the beginning of the year, and income statement variables and stock
return variables are measured over the previous year. We additionally control for firm and year
fixed effects, and in all our regressions we cluster standard errors at the firm level.
Table 3 reports the regression results from estimating Equation (1). We find a
significantly negative coefficient (p-value = 0.021) on CDS Sales when the dependent variable is
MF_N, and an insignificantly negative coefficient on CDS Sales when the dependent variable is
MF_D. The coefficient on CDS Sales in the MF_N specification implies that on average a one
percent increase in the percentage of sales to CDS-traded customers is associated with a decrease
of 0.529 in instances of management forecasts during the year. This is consistent with our
prediction in our first hypothesis that, in general, when more information is available about the
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viability of a firm's major customers, with benefits to disclose decreasing, managers will issue
less frequent earnings forecasts. The insignificantly negative coefficient on CDS Sales when
MF_D is the dependent variable suggests that a higher amount of CDS trading on major
customers may not necessarily induce guiders to discontinue guidance. Discontinuing forecasts is
costly because it might be perceived by the market as suggesting poor future performance or
higher systematic risk, and is associated with negative market reaction (Chen et al. 2011).
Consistent with this notion, research has shown an inertia in the decision to provide guidance:
once firms start to provide guidance, they tend to continue to do so (Lang and Lundholm 1996;
Anilowski Feng and Skinner 2007; Einhorn and Ziv 2008).
4.2 Nature of forecast news
Our results thus far suggest that active CDS trading on a firm's customers has externality
effects, reducing disclosure benefits of the supplier firms. This potentially reduces the need for
managers to provide earnings forecasts, and is thus negatively associated with the overall level of
the firm's management forecast activity, at least in terms of forecast frequency. In this section,
we explore whether the nature of the news conveyed in management forecasts is influenced by
the level of sales to customers with CDS trading.
To investigate how CDS trading on a firm's customers affects the nature of news
conveyed in management forecasts, we use a similar regression model as Equation (1), except we
now use the dependent variables, MF_N and MF_D, to represent issuance of good news and bad
news earnings forecasts, rather than overall management forecasts. Bad news and good news
earnings forecasts are defined similarly as described in Section 3.2. We perform our regressions
separately for good news and bad news forecasts.
Table 4 presents the results for forecast issuance, separately for good news and bad news
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forecasts. We find a significantly negative coefficient on sales to CDS-referenced customers for
good news management forecasts. Specifically, in the regression using MF_N, a one percentage
increase in sales to CDS-referenced customers is associated with an average decrease of 0.15
instances of good news forecasts. In the regression using MF_D, and in contrast to the results on
the likelihood of overall management forecasts, CDS Sales loads significantly negative.
In contrast, for bad news management forecasts, we find that the coefficient on CDS
Sales is insignificantly different from zero in both specifications of MF_N and MF_D.
Combined with Table 3, Table 4 show that the negative relation between customer CDS sales
and overall management forecasts is driven primarily by good news forecasts. The results
suggest that while the CDS market provides a better information environment about the firm,
leading supplier firms to reduce their overall disclosure levels, CDSs also have a disciplining
effect that leads managers to hold off on reduction in bad news disclosure.
4.3 Change analyses and instrumental variable tests
One concern in our setting is that sales to customers with CDS trading and management
forecast issuance may be jointly determined. To address this concern, we perform a difference-
in-differences analysis using the introduction of CDS trading on certain customers, and we also
perform an instrumental variable regression.
First, we perform a difference-in-differences analysis to examine how supplier firms alter
forecast issuance when they begin to have CDS-referenced customers. We take an approach
similar to that used in Li and Tang (2016). Specifically, we begin by examining all four-year
windows from all firms in our sample. We then define a treatment firm as a firm which has sales
to CDS-referenced customers in the third and fourth years of the window, and no sales to CDS-
referenced customers in the first and second years of the window. We are able to identify 113
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unique firms in our sample that have an introduction of sales to CDS-referenced customers in
this fashion. A control firm is defined as having no sales to CDS-referenced customers during the
same four-year window as the treatment firm. We match each treatment firm to the control firm
in the same two-digit SIC industry with the closest level of firm size and information uncertainty
among all potential matches. We use market value of equity to measure firm size and stock
return volatility to measure information uncertainty. Using this approach, we arrive at a sample
of 906 firm-years.
We then run Equation (1) except we replace CDS Sales with two indicator variables,
Treatment and Post, and their interaction, Treatment × Post. Treatment take a value of one for
treatment firms, and zero for control firms. Post takes a value of one for the third and fourth
years, and zero for the first and second years of the four-year window.
Table 5 presents the results that have a similar picture as the main results in Table 4. The
significantly negative coefficient on Treatment × Post for good news forecasts suggests that
following the start of sales to customers referenced by CDSs, the treated firms decrease their
propensity and frequency of issuing good news forecasts, relative to control firms without sales
to CDS-referenced customers. In contrast, and also consistent with our main results, we see an
insignificant difference between treatment and control firms in the change in the provision of bad
news forecasts with the introduction of CDS-referenced customers.
Second, we employ an approach similar to that used in Kim et al. (2017a), where we use
an instrumental variable to proxy for hedging and speculation demand of customers’ bond
investors in the CDS market, which is expected to be related to CDS trading on customers but
not directly related to how the supplier firms of these CDS-referenced entities provide
management forecasts. Oehmke and Zawadowski (2013) and Boehmer et al. (2015) observe that
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the development of CDS market and underlying bond market tend to be inversely related for
individual firms. That is, CDS trading tends to be deeper and more liquid when trading in the
underlying bonds is more difficult and less liquid. Traders looking for credit hedging will
naturally gravitate to the more liquid CDS market for any given firm. Similar to Boehmer et al.
(2015), we use average bond trading volume of customers’ two-digit SIC industry peers to proxy
for investors’ demand for the underlying bonds of customers, and thus as an inverse proxy for
the development of the CDS market of customers. Higher bond trading on a customer’s industry
peers should be negatively associated with the likelihood of CDSs being traded on that customer,
but it is not obvious ex ante why bond trading of customers’ industry peers should be related to
suppliers’ issuance of management forecasts.
Table 6 presents the results using this approach. Similar to our main results in Table 4,
we continue to find a significantly negative effect of sales to CDS customers for good news
management forecasts, and an insignificant effect for bad news forecasts. That is, when the
investors’ bond market demand is lower for customer firms, indicating higher likelihood of a
developed CDS market on that customer, provision of good news forecasts tends to decrease,
while provision of bad news forecasts does not significantly change.
4.4 Litigation risk
To further explore the mechanism through which sales to CDS referenced customers
affect the frequency and propensity for managers to provide management forecasts of different
news nature, we examine the role of litigation risk. Skinner (1994, 1997) finds that managers are
more likely to preemptively disclose forward-looking bad news than good news, and suggests
this may be due to managers’ aversion to legal liability.
We employ a measure of ex-ante litigation risk based on the model developed in Kim and
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Skinner (2012). This model takes into account several variables documented to influence lawsuit
filings, including industry-based litigation risk, and lagged values of firm size, sales growth,
stock return, return skewness, return volatility and turnover. For each firm year, we measure the
ex ante litigation risk by first calculating the fitted values from Kim and Skinner’s model to our
sample, and then define an indicator variable, Litig which equals one if the fitted values are
above the sample median and zero otherwise.7 We include Litig in our regression, as well as an
interaction with CDS Sales to determine its influence on the relation between customer CDS-
referencing and supplier disclosure decisions. We estimate the following regression model
including CDS Sales, Litig, their interaction, along with controls and fixed effects separately for
good news and bad news management forecasts:
εeffectsfixedyearandFirmcontrolsFirmβ
LitigSalesCDSβLitigβSalesCDSββMF_N(MF_D)
i
3210 (2)
As before, this model takes the form of OLS or logistic regression depending on whether
MF_N or MF_D is used.
The results are reported in Table 7. For good news management forecasts, we continue to
find a negative coefficient on the main effect of CDS Sales when Litig is equal to zero, consistent
with our finding in Table 4. However, we find that the coefficients on the main effect of Litig as
well as its interaction with CDS Sales are both insignificantly different from zero, suggesting that
litigation risk does not influence managers' propensity to provide good news forecasts, nor does
it significantly influence the mitigating effect on issuing good news forecasts of sales to CDS-
referenced customers.
In contrast, for bad news management forecasts, we find a significantly positive
7 The model takes the form of Sued=α0+ α1Industry litigation risk+ α2Firm size+ α3Sales growth+ α4Stock return+ α5Return skewness+ α6Return volatility+ α7Turnover+µ. Higher fitted values represent high levels of ex ante litigation risk. In our sample, the fitted values range from -4.59 to 5.83, with the zero value occurring at the 69 percentile.
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coefficient on the interaction between CDS Sales and Litig, suggesting that with the pressure of
timely bad new revelation from CDS-referenced customers, managers would make more bad
news management forecasts to reduce litigation risk. Thus, while CDS trading on customers
overall does not change managers’ bad news disclosure, litigation risk plays a role by making
firms increase their bad news forecasts in response to higher levels of sales to CDS-referenced
customers. As for the main effect of Litig, we find a significantly negative coefficient. This
suggests that when there is no alternative information source to discipline managers for timely
disclosure, firms facing higher ex-ante litigation risk are more reluctant to issue bad news
forecasts, consistent with Johnson et al.'s (2007) argument that bad news forecasts may trigger
lawsuit and this in turn deters bad news forecasts.
4.5 Robustness tests and alternative subsamples
We perform several additional tests and analyses on alternative subsamples, and find that
our results are generally robust to different approaches.
In our sample, 3,655 (33.6%) of the 10,865 firm-years represent supplier firms without
CDS sales to customers in any year during the sample period, while the other 7,210 (67.4%)
represent firms having sales to CDS-referenced customers in at least one year over the sample
period. To control for the potential systematic difference between these two samples, we perform
a test removing the 3,655 firm-years without CDS sales over the sample period.
The results are presented in Table 8. Panel A presents the results based on Equation (1).
For good news management forecasts, MF_N continues to load significantly negative. When we
use MF_D, the coefficient on CDS Sales continues to be negative but falls below conventional
significance levels. Thus, when we only focus on firms with sales to CDS customers in at least
one year during the sample period, variation in the level of such sales is strongly associated with
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the frequency of good news forecasts, but the effect may not be strong enough to dominate the
cost of discontinuing guidance and push a guider to switch to a non-guider. The results on bad
news forecasts continue to be insignificant, consistent with our earlier results.
Panel B of Table 8 reproduces Table 7’s results, based on Equation (2), investigating the
interactive effect of litigation risk on the relation between sales to CDS-referenced customers
and management forecasts. Our results continue to hold—the interaction between CDS Sales and
Litig loads significantly positive for both MF_N and MF_D of bad news forecasts, and
insignificantly for good news forecasts.
The effect of sales to CDS customers on the supplier firms’ management forecasts might
be driven by whether CDSs are being traded on the supplier firms themselves. If one of a firm's
major customers becomes a CDS-referenced entity, then the effect of sales to CDS customers on
the management forecasts of the supplier would likely be contaminated if the supplier firm is
itself a CDS-referenced entity. In our sample, 2,008 of the 10,865 firm-years are from suppliers
which have CDS trading. In Table 9, we reperform our main tests after removing these firm-
years from our sample, and find our main results on the frequency of guidance activity continue
to hold, and our results on guidance propensity strengthen.
Panel A of Table 9 reproduces our main tests of Equation (1). The distinction between
good news and bad news forecast issuance remains: good news forecast issuance is negatively
related to CDS Sales, while bad news forecast issuance is insignificantly related. As for good
news forecasts, the coefficient for forecast frequency (MF_N) loads with similar magnitude and
statistical significance as before, and the coefficient for forecast likelihood (MF_D) strengthens
in both magnitude and statistical significance.
Panel B of Table 9 reproduces our litigation risk tests based on Equation (2), and we see a
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similar main effect of CDS Sales: the results on good news forecast frequency continue to hold,
while the results on good news forecast likelihood strengthen. As for the interaction between
CDS Sales and Litig, the coefficient for bad news forecasts strengthens in both magnitude and
statistical significance when MF_D is used as the dependent variable. The interactions for good
news forecasts, both MF_N and MF_D, continue to remain insignificant.
In Table 10, similar to Kim et al. (2017a), we focus on an alternative measure of CDS
activity, CDS liquidity. As discussed above in our instrumental variable analysis, investors are
more likely to focus on the CDS market for their credit hedging needs if the underlying bond
market for a firm is illiquid or presents trading frictions. We classify a customer as having liquid
CDSs if the average number of distinct dealers providing CDS spread quotes for that customer is
above the sample median for that year. We then measure sales to customers with liquid CDS
trading based on this criterion. Our baseline results and litigation risk results are presented in
Panel A and B, respectively, and are consistent with the results using CDS Sales based on
whether a customer is a reference entity in the CDS market.
Finally, to address the potential concern that the nature of management forecasts issued
by customers and suppliers might be correlated, we re-estimate Equation (1) controlling for
customers' concurrent issuance of good news and bad news management forecasts. In
untabulated analyses, we find that the results remain essentially unchanged.
5 Conclusion
The market for CDSs has been one of the most significant developments in financial
markets in recent years. Prior research has shown that the information conveyed by CDSs has
externality effects beyond the reference firms. This is especially true since SFAS 131 requires
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firms to disclose major customers, thus making public the strong economic linkages between
CDS reference entities and their suppliers.
We examine whether the externality effects of CDS trading on economically linked
customers extend to the provision of management forecasts. In our main tests, we find that firms
decrease their overall level of management forecast issuance when a greater proportion of their
revenue is derived from CDS-referenced customers. This evidence is consistent with CDSs
acting as an additional public information source with regard to the reference entities’ suppliers.
Furthermore, we find that this reduction in management forecasts in response to higher
sales to CDS-referenced customers varies non-randomly with the nature of the news conveyed in
forecasts. The negative relation is driven by good news forecasts, but not by bad news forecasts.
These results are robust to a number of subsample analyses and tests that address potential joint
determination of CDS customer sales and management forecast issuance.
Expanding our analyses, we then explore the role of litigation risk in moderating the
relation between management forecasts and sales to CDS-referenced customers. We find that
increased litigation risk does not significantly influence the relation between good news forecasts
and sales to CDS-referenced customers. However, we find a significantly positive interaction
between sales to CDS-referenced customer and the supplier firm’s bad news forecasts,
suggesting that heightened litigation risk disciplines managers of the supplier firm to make more
timely disclosure of bad news when the news would otherwise be revealed by an alternative
source of CDS market.
Our study contributes to both the literature on the determinants of management forecasts,
and the growing literature examining the impact of CDSs. We shed light on how the CDS market
can provide information that affects managers’ tradeoff between costs and benefits when
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deciding whether to provide forecasts and, if so, what kind of forecasts to provide. We also show
that the determinants of management forecast issuance and its nature come not just from the
issuing firm itself, but from economically linked firms as well.
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Kim, I., D. Skinner. 2012. Measuring Securities Litigation Risk. Journal of Accounting and Economics 53 (1-2): 290-310. Kim, J. B., B. Song, Y. Zhang. 2015. Earnings Performance of Major Customers and Bank Loan Contracting with Suppliers. Journal of Banking & Finance 59: 384-398. Lambert, R., C. Leuz, R. Verrecchia. 2007. Accounting Information, Disclosure, and the Cost of Capital. Journal of Accounting Research 45 (2): 385-420. Landsman, W., C. Li, J. Zhao. 2017. The Effect of CDS Trading Initiation on Dividend Payout Policy. Working paper. Lang, M., R. Lundholm. 1996. Corporate Disclosure Policy and Analyst Behavior. The Accounting Review 71 (4): 467-492. Leary, M., Roberts, M.R. 2014. Do Peer Firms Affect Corporate Financial Policy? Journal of Finance 69(1):139-178. Li, J. Y., D. Y. Tang. 2016. The Leverage Externalities of Credit Default Swaps. Journal of Financial Economics 120: 491-513. Luo, S., N. Nagarajan. 2015. Information Complementarities and Supply Chain Analysts. The Accounting Review 90 (5): 1995-2029 Ma, S. 2017. Economic Links and the Spillover Effect of Earnings Quality on Market Risk. Forthcoming, The Accounting Review. Martin X, S. Roychowdhury. 2015. Do Financial Market Developments Influence Accounting Practices? Credit Default Swaps and Borrowers’ Reporting Conservatism. Journal of Accounting and Economics 59 (1): 80-104. Oehmke, M., A. Zawadowski. 2017. The Anatomy of the CDS Market. Review of Financial Studies 30 (1): 80-119. Pandit, S., C. Wasley, T. Zach. 2011. Information Externalities along the Supply Chain: The Economic Determinants of Suppliers’ Stock Price Reaction to Their Customers’ Earnings Announcements. Contemporary Accounting Research 28 (4): 1304-1343. Radhakrishnan, S., Z. Wang, Y. Zhang. 2014. Customers' Capital Market Information Quality and Suppliers' Performance. Production and Operations Management 23 (10): 1690-1705. Rogers, J., Van Buskirk, A., 2013. Bundled Forecasts in Empirical Accounting Research. Journal of Accounting and Economics 55, 43-65. Saretto, A., H. Tookes. 2013. Corporate Leverage, Debt Maturity, and Credit Supply: The Role
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of Credit Default Swaps. Review of Financial Studies 26 (5): 1190-1247 K. Shue. 2013. Executive Networks and Firm Policies: Evidence from the Random Assignment of MBA Peers. The Review of Financial Studies 26(6):1401-1442. Skinner, D. 1994. Why Firms Voluntarily Disclose Bad News. Journal of Accounting Research 32 (1): 38-60. Skinner, D. 1997. Earnings Disclosures and Stockholder Lawsuits. Journal of Accounting and Economics 23 (3): 249-82. Subrahmanyam, M.G., D. Y. Tang., S. Q. Wang. 2014. Does the Tail Wag the Dog? Credit Default Swaps and Credit Risk. Review of Financial Studies 27: 2927-1960. Tang, D., F. Tian, H. Yan. 2015. Internal Control Quality and Credit Default Swap Spreads. Accounting Horizons 29 (3): 603-629. Verrecchia, R.. 2001. Essays on Disclosure. Journal of Accounting and Economics 32:91-180. Zhang, G., S. Zhang. 2013. Information Efficiency of the U.S. Credit Default Swap Market: Evidence from Earnings Surprises. Journal of Financial Stability 9 (4): 720-730.
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Appendix A Variable Definitions MF_N — The number of management forecasts issued during a year. MF_D — The likelihood of issuing management guidance during a year. This is an indicator variable taking a value of 1 if managers issue at least one piece of guidance in the period, and 0 otherwise. Good news / bad news — Classification of the nature of the management guidance. We use the I/B/E/S provided classification which is based on a comparison of the forecasted earnings to the consensus analyst forecast as the time of issuance. CDS Sales — Sales to customers with CDS trading as a proportion of a supplier's total sales. Litig — Ex ante litigation risk based on Kim and Skinner (2012), calculated as the fitted values from the model Sued=α0+ α1Industry litigation risk+ α2Firm size+ α3Sales growth+ α4Stock return+ α5Return skewness+ α6Return volatility+ α7Turnover+µ. Analyst Following — The number of unique analysts who issue forecasts for the firm in the previous year. Size — Market value (in millions), measured at the end of the previous year; for regressions, we use the natural logarithm of this variable. M/B — The ratio of market value to book value of equity, measured at the end of the previous year. Return Volatility — Volatility of daily stock returns in the previous year. ROA — The ratio of earnings to total assets in the previous year. Loss — Indicator for loss in the previous year, defined as one if earnings are negative, and zero otherwise. Prior Return — Cumulative stock returns in the previous year.
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Table 1 Sample Selection and Composition
The sample consists of 10,865 firm-years (representing 2,448 unique firms) over the period [2002, 2012]. Panel A lists the sample selection procedures. Panel B provides a breakdown of the number of firms per year, as well as the average number of customers per firm, and how many of them are CDS-referenced. Panel A Sample Selection Number of
firms Number of
firm-years (1) Observations with customers' CDS data
from 2002-2012 2,671
11,763
(2) Sample after eliminating observations
with missing data 2,448
10,865
Observations with customer firms having traded CDS contracts
1,758
5,437
Panel B Sample Firms over Time
Fiscal Year
Number of
supplier firms
Mean number of customers per supplier firm
Number of
customer firms with active CDS
Number of supplier
firms with CDS-referenced customers
2002 785 1.94 625 321 2003 1,153 1.96 1,037 540 2004 1,155 1.95 1,123 560 2005 1,100 1.93 1,172 560 2006 1,093 1.9 1,124 568 2007 1,090 1.95 1,191 575 2008 1,056 1.91 1,121 549 2009 1,044 2.02 1,139 561 2010 1,012 2.09 1,057 495 2011 947 2.16 1,023 488 2012 430 2.4 474 220
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Tab
le 2
D
escr
ipti
ve S
tati
stic
s P
anel
A
Des
crip
tive
Sta
tist
ics
on t
he
Reg
ress
ion
Var
iab
les
The
sam
ple
cons
ists
of
10,8
65 f
irm
-yea
rs (
repr
esen
ting
2,4
48 u
niqu
e fi
rms)
ove
r th
e pe
riod
[20
02,
2012
].
Pan
el A
pre
sent
s de
scri
ptiv
e st
atis
tics
of
mai
n va
riab
les.
P
anel
B p
rese
nts
univ
aria
te c
orre
lati
ons
amon
g th
e in
depe
nden
t va
riab
les.
R
efer
to
the
App
endi
x fo
r va
riab
le d
efin
itio
ns.
The
sym
bols
•••
, ••
, an
d •
repr
esen
t st
atis
tica
l si
gnif
ican
ce a
t th
e 1%
, 5%
, an
d 10
%,
leve
ls,
resp
ecti
vely
.
Ran
ge p
erce
ntil
es
Mea
n
5%
25
%
50
%
75
%
95
%
S
td. d
ev.
MF
_N (
over
all)
1.95
6
0
0
0
3
9
3.51
5 M
F_D
(ov
eral
l)
0.
342
0
0
0
1
1
0.
474
MF
_N (
good
new
s)
0.
632
0
0
0
0
4
1.
447
MF
_D (
good
new
s)
0.
238
0
0
0
0
1
0.
426
MF
_N (
bad
new
s)
0.
945
0
0
0
1
5
1.
948
MF
_D (
bad
new
s)
0.
284
0
0
0
1
1
0.
451
CD
S Sa
les
0.
192
0
0
0.
126
0.
288
0.
68
0.
224
Ana
lyst
Fol
low
ing
7.
095
0
0
4
10
25
8.
712
Size
(in
mil
lion
s)
2,
620
14
83
33
5
1,25
8
9,48
2
11,6
29
M/B
2.70
2
0.27
3
1.18
1.96
2
3.34
2
8.65
4
3.90
0 R
etur
n V
olat
ilit
y
3.33
3
1.46
5
2.32
1
3.13
4.16
5
5.87
3
1.34
2 R
OA
−0.
054
−
0.57
3
−0.
078
0.
026
0.
073
0.
169
0.
261
Los
s
0.38
7
0
0
0
1
1
0.48
7 P
rior
Ret
urn
(%)
−
0.07
3
−82
.302
−
24.2
43
1.17
8
27.2
71
74
.331
46.8
38
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Tab
le 2
D
escr
ipti
ve S
tati
stic
s (c
onti
nu
ed)
Pan
el B
C
orre
lati
ons
amon
g th
e In
dep
end
ent
Var
iab
les
C
DS
sale
s
A
naly
st
Fol
low
ing
Si
ze
M
/B
R
etur
n V
olat
ilit
y
RO
A
L
oss
Ana
lyst
Fol
low
ing
0.01
7
Size
(in
mil
lion
s)
0.01
7
0.
354•
•
M/B
−
0.00
3
0.
074•
•
0.07
9••
Ret
urn
Vol
atil
ity
−0.
008
−0.
242•
•
−0.
220•
•
−0.
068•
•
RO
A
−0.
016
0.14
3••
0.
113•
•
0.01
1
−0.
465•
•
L
oss
0.01
7
−
0.14
2••
−
0.13
5••
−
0.02
5••
0.
451•
•
−0.
633•
•
Pri
or R
etur
n 0.
013
0.05
7••
0.
040•
•
0.18
2••
−
0.12
6••
0.
357•
•
−0.
281
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Table 3 Sales to CDS Customers and Management Forecast Issuance
This table reports the effect of sales to a CDS-referenced customer on the supplier's management forecast issuance. We use OLS (Logit) regression specification when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported to the right of each coefficient, and are two-sided and based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively.
All Management Forecasts MF_N MF_D Coefficient p-value Coefficient p-value Intercept 0.589 0.146 CDS Sales −0.529 0.021•• −0.094 0.850 Analyst Following 0.029 0.000••• 0.037 0.022•• Size 0.339 0.000••• 0.826 0.000••• M/B 0.005 0.504 0.001 0.931 Return Volatility −0.123 0.001••• −0.095 0.244 ROA 0.357 0.014•• 0.863 0.060• Loss −0.193 0.007••• −0.340 0.022•• Prior Return −0.001 0.053• −0.003 0.018•• Firm fixed effects Yes Yes Year fixed effects Yes Yes N 10,865 10,865 Adjusted R2 4.45% 13.92%
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Table 4 Sales to CDS Customers and Management Forecast Issuance — Nature of News
This table reports the effect of sales to a CDS-referenced customer on the supplier's disclosure of good news and bad news management forecasts. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported below each coefficient, and are two-sided and based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively.
Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.602••• −0.524••• 0.000 0.001 CDS Sales −0.150•• −0.772•• −0.072 −0.054 0.014 0.040 0.384 0.893 Analyst Following 0.006••• 0.027••• 0.001 −0.003 0.006 0.003 0.657 0.723 Size −0.032 0.064 0.233••• 1.078••• 0.131 0.544 0.000 0.000 M/B 0.001 0.021 −0.003 −0.004 0.717 0.142 0.368 0.810 Return Volatility −0.030••• −0.150•• −0.032•• −0.091 0.019 0.036 0.028 0.218 ROA −0.012 −0.077 0.142•• 0.882•• 0.725 0.813 0.012 0.032 Loss 0.011 −0.073 −0.128••• −0.359••• 0.622 0.594 0.000 0.008 Prior Return 0.001••• 0.001 −0.002••• −0.006••• 0.002 0.250 0.000 0.000 Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 10,865 10,865 10,865 10,865 Adjusted/Pseudo R2 0.70% 1.78% 3.67% 9.83%
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Table 5 Sales to CDS Customers and Management Forecast Issuance – Difference-in-Differences
This table reports the effect of sales to CDS-referenced customer on the supplier's disclosure of good news and bad news management forecasts, based on a matched sample of treated and control suppliers. A treated supplier is defined as having CDS-referenced customers in the third and fourth years of a four-year window and having no CDS-referenced customers in the first and second years. A control supplier is defined as having no CDS-referenced customers over the four-year window. Control firms are in the same two-digit SIC industry as the treated supplier and their firm size and stock return volatility are the closest to the treated supplier among all potential matches. Treat is equal to one for the treated supplier and zero otherwise. Post is equal to one for the third and fourth year, and zero otherwise. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. The p-values are reported below each coefficient, and are two-sided and based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively. Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 1.377 −0.214
0.130 0.680
Treat 0.418 1.018 0.228 1.572•• 0.223 0.229 0.337 0.046
Post 0.398• 0.880 0.083 0.9450.083 0.187 0.503 0.144
Treat × Post −0.196•• −1.021• −0.091 −0.3430.043 0.098 0.378 0.593
Analyst Following −0.007 0.017 0.014 0.0790.512 0.799 0.206 0.192
Size −0.151 −0.694 0.063 0.8500.254 0.346 0.435 0.173
M/B 0.004 0.070 0.003 0.1700.663 0.678 0.722 0.167
Return Volatility −0.086 −0.280 0.029 0.2860.180 0.391 0.549 0.436
ROA −0.120 −1.162 −0.014 6.735•• 0.401 0.463 0.930 0.010
Loss 0.077 −0.105 −0.357•• −0.5880.411 0.878 0.014 0.398
Prior Return 0.002•• 0.006 −0.001 −0.0030.014 0.208 0.583 0.623
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 904 904 904 904 Adjusted/Pseudo R2 9.73% 18.89% 8.02% 20.40%
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Table 6 Sales to CDS Customers and Management Forecast Issuance –
Instrumental Variable Analysis This table reports the effect of sales to a CDS–referenced customer on the supplier’s disclosure of good news and bad news management forecasts, based on an instrumental variable analysis. CDS Sales is instrumented by Bond Investor Demand of Customers, proxying for bond investors’ hedging and speculative demand in the CDS market. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported below each coefficient, and are two-sided and based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively. Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 1.183••• −1.030• 0.001 0.054
CDS Sales −3.065• −29.929• 3.065 −0.973 0.093 0.058 0.344 0.955
Analyst Following 0.006•• 0.037••• 0.001 0.002 0.015 0.003 0.753 0.877
Size −0.025 0.164 0.220••• 1.009••• 0.344 0.216 0.000 0.000
M/B −0.005 −0.027 0.001 −0.019 0.142 0.324 0.877 0.536
Return Volatility −0.049••• −0.212••• −0.031• −0.103 0.001 0.006 0.056 0.217
ROA 0.094 1.167 0.071 1.081 0.258 0.107 0.614 0.183
Loss −0.018 −0.296 −0.099•• −0.345• 0.536 0.110 0.016 0.074
Prior Return 0.001••• 0.002 −0.002••• −0.006••• 0.002 0.139 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 9,512 9,512 9,512 9,512 Adjusted/Pseudo R2 0.65% 1.56% 3.87% 9.92%
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Table 7 Sales to CDS Customers and Management Forecast Issuance –
Conditional on Litigation Risk This table reports the effect of sales to a CDS-referenced customer on the supplier’s management forecasts, conditional on Litig. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported below each coefficient, and are two-sided and are based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively. Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.631••• -0.543•••
0.000 0.001
CDS Sales -0.154•• -0.856 -0.212••• -0.4600.045 0.060 0.040 0.347
CDS Sales × Litig 0.005 0.141 0.249••• 0.706• 0.942 0.736 0.010 0.091
Litig 0.034 0.091 -0.091••• -0.2150.163 0.482 0.004 0.103
Analyst Following 0.006••• 0.027 0.001 -0.0040.006 0.003 0.691 0.705
Size -0.035 0.052 0.238••• 1.085••• 0.101 0.627 0.000 0.000
M/B 0.001 0.021 -0.003 -0.0050.692 0.141 0.323 0.733
Return Volatility -0.039••• -0.183•• -0.021 -0.0710.005 0.020 0.184 0.362
ROA -0.012 -0.081 0.138•• 0.868•• 0.721 0.802 0.014 0.033
Loss 0.012 -0.070 -0.129••• -0.364••• 0.606 0.610 0.000 0.007
Prior Return 0.001••• 0.001 -0.002••• -0.006••• 0.004 0.281 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 10,865 10,865 10,865 10,865 Adjusted/Pseudo R2 0.70% 4.10% 3.73% 13.42%
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Table 8 Sales to CDS Customers and Management Forecast Issuance –
Excluding Suppliers with no CDS-referenced Customers This table reports the effect of sales to a CDS-referenced customers on the supplier’s disclosure of good news and bad news management forecasts, based on the subsample excluding suppliers without CDS-referenced customers over the sample period. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported below each coefficient, and are two-sided and are based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively. Panel A Baseline Results Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.548••• -0.551••• 0.004 0.010
CDS Sales -0.157• -0.594 -0.099 0.080 0.077 0.258 0.389 0.878
Analyst Following 0.007••• 0.032••• 0.003 0.001 0.010 0.008 0.394 0.947
Size -0.019 0.042 0.239••• 1.057••• 0.455 0.743 0.000 0.000
M/B -0.003 0.008 -0.003 -0.006 0.210 0.621 0.413 0.745
Return Volatility -0.026• -0.144 -0.033• -0.033 0.079 0.076 0.088 0.714
ROA -0.013 0.030 0.285••• 0.780 0.809 0.945 0.001 0.117
Loss 0.008 -0.073 -0.085•• -0.405•• 0.802 0.670 0.027 0.013
Prior Return 0.000 0.001 -0.002••• -0.006••• 0.238 0.689 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 7,210 7,210 7,210 7,210 Adjusted/Pseudo R2 0.57% 1.88% 4.05% 10.01%
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Table 8 (continued) Sales to CDS Customers and Management Forecast Issuance –
Excluding Suppliers with no CDS-referenced Customers Panel B Litigation Risk Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.587••• −0.526••
0.002 0.015
CDS Sales −0.161 −0.613 −0.327•• −0.6730.122 0.314 0.023 0.280
CDS Sales × Litig 0.005 0.033 0.409••• 1.315•• 0.957 0.951 0.001 0.012
Litig 0.046 0.203 −0.160••• −0.487•• 0.256 0.292 0.003 0.011
Analyst Following 0.007••• 0.032••• 0.003 0.0000.008 0.007 0.458 0.971
Size −0.024 0.018 0.245••• 1.073••• 0.352 0.891 0.000 0.000
M/B −0.003 0.008 −0.003 −0.0090.207 0.610 0.416 0.637
Return Volatility −0.037•• −0.203•• −0.023 −0.0070.018 0.027 0.275 0.938
ROA −0.013 0.041 0.254••• 0.7540.814 0.923 0.002 0.121
Loss 0.009 −0.065 −0.092•• −0.423••• 0.780 0.705 0.016 0.009
Prior Return 0.000 0.000 −0.002••• −0.006••• 0.322 0.760 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 7,210 7,210 7,210 7,210 Adjusted/Pseudo R2 0.57% 1.88% 4.05% 10.01%
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Table 9 Sales to CDS Customers and Management Forecast Issuance –
Excluding Suppliers with Active CDS Trading This table reports the effect of sales to a CDS-referenced customers on the supplier's disclosure of good news and bad news management forecasts, based on the subsample excluding suppliers with active CDS trading. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported below each coefficient, and are two-sided and are based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively. Panel A Baseline Results Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.492••• −0.604••• 0.000 0.000
CDS Sales −0.187••• −1.405••• −0.042 −0.023 0.002 0.001 0.607 0.962
Analyst Following 0.008••• 0.037••• −0.001 −0.012 0.005 0.002 0.824 0.389
Size −0.024 0.082 0.244••• 1.331••• 0.207 0.476 0.000 0.000
M/B 0.000 0.008 −0.007••• −0.055•• 0.941 0.640 0.002 0.013
Return Volatility −0.026•• −0.146• −0.018 −0.031 0.023 0.072 0.216 0.710
ROA −0.032 −0.228 0.106• 0.522 0.348 0.502 0.065 0.234
Loss −0.010 −0.135 −0.150••• −0.435••• 0.680 0.390• 0.000••• 0.006
Prior Return 0.001••• 0.002 −0.001 −0.006••• 0.002 0.085 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 8,857 8,857 8,857 8,857 Adjusted/Pseudo R2 0.82% 2.48% 4.31% 12.60%
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Table 9 (continued) Sales to CDS Customers and Management Forecast Issuance –
Excluding Suppliers with Active CDS Trading Panel B Litigation Risk Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.515••• −0.622•••
0.000 0.000
CDS Sales −0.202••• −1.714••• −0.172• −0.6890.007 0.001 0.090 0.243
CDS Sales × Litig 0.024 0.529 0.230•• 1.179•• 0.738 0.258 0.019 0.016
Litig 0.021 0.023 −0.083•• −0.279• 0.378 0.878 0.011 0.072
Analyst Following 0.008••• 0.036••• −0.001 −0.0130.005 0.003 0.815 0.353
Size −0.026 0.070 0.249••• 1.343••• 0.174 0.546 0.000 0.000
M/B 0.000 0.008 −0.007••• −0.058••• 0.912 0.648 0.001 0.008
Return Volatility −0.032••• −0.180••• −0.008 −0.0200.007 0.040 0.616 0.821
ROA −0.033 −0.237 0.103• 0.4990.342 0.473 0.073 0.249
Loss −0.009 −0.134 −0.151••• −0.438••• 0.688 0.391 0.000 0.005
Prior Return 0.001••• 0.002 −0.001••• −0.006••• 0.003 0.110 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 8,857 8,857 8,857 8,857 Adjusted/Pseudo R2 0.84% 2.60% 4.43% 12.89%
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Table 10 Sales to CDS Customers and Management Forecast Issuance — CDS Liquidity
This table reports the effect of sales to a CDS-referenced customer on the supplier’s disclosure of good news and bad news management forecasts, based on sales to customers with liquid CDSs. A customer is classified as with liquid CDSs if average number of distinct dealers providing CDS spread quotes for the firm during a year is above the sample median for that year. We use OLS (Logit) regression when MF_N (MF_D) is the dependent variable. Please see the Appendix for variable definitions. The p-values are reported below each coefficient, and are two-sided and are based on standard errors adjusted for firm-level clustering. The symbols •••, ••, and • represent statistical significance at the 1%, 5%, and 10%, levels, respectively. Panel A Baseline Results Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.601••• −0.530••• 0.000 0.001
CDS Sales −0.151•• −0.672• −0.033 −0.006 0.024 0.094 0.715 0.989
Analyst Following 0.006••• 0.027••• 0.001 −0.004 0.006 0.003 0.659 0.719
Size −0.032 0.071 0.233••• 1.078••• 0.136 0.502 0.000 0.000
M/B 0.001 0.021 −0.003 −0.004 0.710 0.132 0.378 0.808
Return Volatility −0.030•• −0.144•• −0.032•• −0.091 0.021 0.044 0.029 0.220
ROA −0.014 −0.080 0.140•• 0.880•• 0.697 0.804 0.013 0.032
Loss 0.012 −0.064 −0.128••• −0.359••• 0.617 0.639 0.000 0.008
Prior Return 0.001••• 0.001 −0.002••• −0.006••• 0.003 0.284 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 10,865 10,865 10,865 10,865 Adjusted/Pseudo R2 0.82% 1.72% 3.66% 9.83%
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Table 10 (continued) Sales to CDS Customers and Management Forecast Issuance — CDS Liquidity
Panel B Litigation Risk Good News Forecasts Bad News Forecasts MF_N MF_D MF_N MF_D Intercept 0.630••• −0.554•••
0.000 0.001
CDS Sales −0.157 −0.721 −0.165 −0.4480.067 0.133 0.155 0.369
CDS Sales × Litig 0.010 0.071 0.236•• 0.803• 0.902 0.873 0.027 0.059
Litig 0.033 0.109 −0.082••• −0.214• 0.153 0.388 0.008 0.093
Analyst Following 0.006••• 0.027••• 0.001 −0.0040.005 0.003 0.685 0.705
Size −0.035 0.059 0.238••• 1.090••• 0.104 0.580 0.000 0.000
M/B 0.001 0.021 −0.003 −0.0050.685 0.131 0.347 0.741
Return Volatility −0.038••• −0.178•• −0.021 −0.0710.005 0.024 0.180 0.363
ROA −0.014 −0.084 0.136•• 0.852•• 0.692 0.795 0.015 0.037
Loss 0.012 −0.061 −0.129••• −0.364••• 0.602 0.656 0.000 0.007
Prior Return 0.001••• 0.001 −0.002••• −0.006••• 0.004 0.316 0.000 0.000
Firm fixed effects Yes Yes Yes Yes Year fixed effects Yes Yes Yes Yes N 10,865 10,865 10,865 10,865 Adjusted/Pseudo R2 0.72% 1.77% 3.75% 9.95%