Debt Contracts, Loss Given Default and Accounting Information

Abstract:     
This study investigates an unexplored important channel, loss given default (LGD), through which accounting measures may shape the design of debt contracts. I find that a select set of accounting measures available at contract initiation, possess significant power for predicting realized LGD at the subsequent default date. I exploit this to construct an accounting-based measure of expected LGD for a large sample of bond issuances. I find that this measure is positively associated with the issuance date interest rate spread, increased probability of the debt being secured, shorter debt maturity, smaller debt size and tighter covenants. Moreover, this measure is the main channel through which the accounting measures I use are associated with debt pricing. I also show that the positive relation between the accounting-based expected LGD and contract terms is higher when probability of default, managerial entrenchment, or accounting information precision are higher.

Number of Pages in PDF File: 52

Keywords: Debt contracts, Loss given default, Bankruptcy, Accounting information, Accounting quality

working papers series