Accounting-based Expected Loss Given Default and Debt Contract Design

41 Pages Posted: 2 Aug 2011 Last revised: 19 Feb 2021

See all articles by Dan Amiram

Dan Amiram

Tel Aviv University - Coller School of Management

Edward Owens

University of Utah - David Eccles School of Business

Date Written: February 10, 2021

Abstract

We investigate an unexplored channel—loss given default (LGD)—through which accounting information can shape the design of debt contracts. Using a sample of defaulted bonds, we find that borrower accounting information available at contract initiation possesses significant power for predicting realized LGD at the subsequent default date. We then use this model to construct an accounting-based measure of expected LGD at the contracting date for a large sample of bond issuances. We find that this measure is positively associated with issuance date interest spread and covenant use, and document that these relations are not artifacts of an association between LGD and probability of default. We then show that accounting-based expected LGD has a stronger association with issuance date spread when the borrower’s underlying accounting is more conservative, consistent with the idea that expected LGD calculations provide a source of lenders’ demand for accounting conservatism. Our results increase our understanding of both the informational role and contracting role of accounting information.

Keywords: Debt contracts; Loss given default; Conservatism

JEL Classification: G12, M40, M41

Suggested Citation

Amiram, Dan and Owens, Edward, Accounting-based Expected Loss Given Default and Debt Contract Design (February 10, 2021). Available at SSRN: https://ssrn.com/abstract=1903721 or http://dx.doi.org/10.2139/ssrn.1903721

Dan Amiram (Contact Author)

Tel Aviv University - Coller School of Management ( email )

Tel Aviv
Israel

Edward Owens

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States
8015815732 (Phone)

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