Information Asymmetry, the Cost of Debt, and Credit Events

Abstract:     
We hypothesize that an increase in information asymmetry causes an increase in both expected and actual losses to debtholders. To test this, we identify exogenous increases in information asymmetry using the loss of an analyst that results from broker closures and broker mergers. We find that the loss of an analyst causes the cost of debt to increase by 25 basis points for treatment firms compared to control firms. Moreover, the rate of credit events (such as defaults) is roughly 100-150% higher than for similar firms that do not lose an analyst. These results are significantly stronger for firms that are smaller, have less analyst coverage, have higher leverage, have a lower credit rating, have shorter debt maturity, and have a bigger increase in information asymmetry.

Number of Pages in PDF File: 39

Keywords: Information asymmetry, Cost of debt, Default, Bankruptcy, Natural experiment, Matching estimators, Difference-in-differences, Equity research analysts

JEL Classification: D80, G12, G24, G33

working papers series