Assessing the Accuracy of Forward-Looking Information in Debt Contract Negotiations: Management Forecast Accuracy and Private Loans

52 Pages Posted: 21 Jan 2015 Last revised: 5 Jun 2020

See all articles by Peter R. Demerjian

Peter R. Demerjian

University of Illinois at Chicago

John Donovan

University of Notre Dame - Department of Accountancy

Jared N. Jennings

Washington University in St. Louis

Date Written: March 13, 2019

Abstract

We examine a possible mechanism by which the lender can evaluate the borrower’s ability to produce accurate forward-looking information. Forward-looking information is important to lenders to project the borrower’s future performance and the loan’s expected payoff. However, unlike historical financial statements, forward-looking information cannot be verified by lenders or external auditors. We contend that the borrower’s past forecast accuracy provides a measure that allows the lender to assess the borrower’s ability to produce accurate forward-looking information, allowing the lender to gain greater confidence in the borrower’s projections of future value. Consistent with this argument, we find that the borrower’s past forecast accuracy is negatively associated with the loan’s initial interest spread. We also find that this relation is concentrated among non-relationship loans and borrowers with greater earnings volatility. Finally, we find that debt contracts to borrowers with more accurate managerial forecasts exhibit less interest rate mispricing.

Keywords: Debt Contracting; Cost of Debt; Management Forecasts; Voluntary Disclosure

JEL Classification: G30, M40, M41

Suggested Citation

Demerjian, Peter R. and Donovan, John and Jennings, Jared N., Assessing the Accuracy of Forward-Looking Information in Debt Contract Negotiations: Management Forecast Accuracy and Private Loans (March 13, 2019). Available at SSRN: https://ssrn.com/abstract=2553049 or http://dx.doi.org/10.2139/ssrn.2553049

Peter R. Demerjian (Contact Author)

University of Illinois at Chicago ( email )

601 South Morgan Street
University Hall, Room 2303
Chicago, IL 60607
United States

John Donovan

University of Notre Dame - Department of Accountancy ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Jared N. Jennings

Washington University in St. Louis ( email )

One Brookings Drive
Campus Box 1208
Saint Louis, MO MO 63130-4899
United States

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