Creditors’ Expected Recovery and Internal Control Quality: Evidence from Credit Default Swaps

44 Pages Posted: 16 Mar 2012

See all articles by Dragon Yongjun Tang

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics

Feng Tian

Hong Kong Polytechnic University

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Date Written: March 14, 2012

Abstract

Prior studies find significant reactions in credit markets, but not in the equity market, to SOX 404 internal control disclosures. Because creditors’ expected recovery, the complement of expected loss given default, affects creditors but not equity-holders, it could provide a unique angle to understand such differential findings. Using credit default swaps (CDS) and expected default frequency (EDF) data, we estimate the expected recovery component in CDS spreads. We find that creditors’ expected recovery is significantly lower for firms reporting internal control material weaknesses. This effect concentrates among firms with high default risk where the concern for recovery is most relevant. Furthermore, creditors’ expected recovery is only sensitive to the more severe type of (company-level) internal control material weaknesses.

Keywords: Internal control weaknesses, credit default swaps, EDF, recovery value

JEL Classification: M41, G00, G32, K22

Suggested Citation

Tang, Dragon Yongjun and Tian, Feng and Yan, Hong, Creditors’ Expected Recovery and Internal Control Quality: Evidence from Credit Default Swaps (March 14, 2012). Available at SSRN: https://ssrn.com/abstract=2023112 or http://dx.doi.org/10.2139/ssrn.2023112

Dragon Yongjun Tang

The University of Hong Kong - Faculty of Business and Economics ( email )

KKL 1004
Pokfulam Road
Pokfulam
Hong Kong
(852)22194321 (Phone)

Feng Tian

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

Hong Yan (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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