Accounting Information Quality and CDS Term Structure

Abstract

We empirically examine the relationship between accounting information quality and the term structure of credit default swap (CDS) spreads. To do so, we capitalize on Flatness—a market-driven and theoretically motivated measure of information quality, which we construct as the ratio of short-term to long-term CDS spreads. We offer three complementary pieces of evidence that Flatness reflects accounting information quality: (i) Flatness increases when the analysts’ consensus earnings forecast is likely achieved via accruals management; (ii) earnings response coefficients decrease in Flatness; and (iii) the predictability of earnings for future cash flow decreases in Flatness. In contrast, we find no evidence that these relationships extend to cash flows. Collectively, our findings indicate that Flatness correlates predictably with the quality of accounting information, offering support for Duffie and Lando’s (2001) theory and subsequent research that builds on it. 

Keywords: accounting information quality, credit default swaps, term structure, meeting or beating analysts’ consensus, earnings management, ERC, the predictive ability of earnings

JEL Classification: D80, G10, M41