Do Financial Market Developments Influence Accounting Practices? Credit Default Swaps and Borrowers’ Asymmetric Loss Recognition Timeliness

40 Pages Posted: 2 Nov 2009 Last revised: 7 Nov 2010

See all articles by Guojin Gong

Guojin Gong

Penn State University - Smeal College of Business

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Sugata Roychowdhury

Boston College

Date Written: November 4, 2010

Abstract

Lenders can transfer credit risk by purchasing credit default swaps (CDS), but holding swaps can diminish their incentives to monitor borrowers. Contracting theory predicts that lenders demand conservatism, in particular asymmetric timeliness of loss recognition, to effectively monitor borrowers. We hypothesize that the onset of CDS trading reduces lenders’ demand for conservatism from borrowing firms. In empirical analyses, we find that the onset of CDS trading is associated with a reduction in borrowing firms’ asymmetric loss recognition timeliness. This reduction is more pronounced when lenders have stronger monitoring incentives prior to the onset of CDS trading. Further, the decline in conservatism with CDS trading initiation is less pronounced during the recent economic crisis, when counter-party risk in CDS contracts increased sharply.

Keywords: credit default swaps, timely loss recognition, conservatism, economic crisis, financial market developments, lender monitoring

JEL Classification: G1, G2, G21, G30, M40, M41, M44

Suggested Citation

Gong, Guojin and Martin, Xiumin and Roychowdhury, Sugata, Do Financial Market Developments Influence Accounting Practices? Credit Default Swaps and Borrowers’ Asymmetric Loss Recognition Timeliness (November 4, 2010). Available at SSRN: https://ssrn.com/abstract=1498600 or http://dx.doi.org/10.2139/ssrn.1498600

Guojin Gong

Penn State University - Smeal College of Business ( email )

University Park, PA 16802
United States
814-863-7055 (Phone)

Xiumin Martin (Contact Author)

Washington University in Saint Louis - Olin School of Business ( email )

Saint Louis, MO 63130
United States

Sugata Roychowdhury

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617-552-1764 (Phone)

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