Does Other Comprehensive Income Volatility Influence Credit Risk and the Cost of Debt?

48 Pages Posted: 24 Mar 2017 Last revised: 30 Jun 2019

See all articles by May Xiaoyan Bao

May Xiaoyan Bao

University of New Hampshire - Peter T. Paul College of Business and Economics

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance

David B. Smith

University of Nebraska at Lincoln - School of Accountancy

Emre Unlu

University of Nebraska at Lincoln

Date Written: May 29, 2019

Abstract

We examine the usefulness of other comprehensive income (OCI) to debt investors in nonfinancial companies. Motivated by Merton’s (1974) real options framework, we construct a measure of incremental OCI volatility, designed to capture the effect of OCI on overall firm asset volatility, which is a primary driver of credit risk in Merton’s (1974) model. We find that the volatility of incremental OCI influences the likelihood of default, credit ratings, and the cost of debt. Overall, our evidence suggests that creditors use information from OCI in their assessment of firm credit risk and in pricing debt contracts.

Keywords: Incremental OCI Volatility, Risk Relevance, Accumulated Other Comprehensive Income, Debt Contracting

JEL Classification: G31, M41, M48

Suggested Citation

Bao, May Xiaoyan and Billett, Matthew T. and Smith, David B. and Unlu, Emre, Does Other Comprehensive Income Volatility Influence Credit Risk and the Cost of Debt? (May 29, 2019). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2939958 or http://dx.doi.org/10.2139/ssrn.2939958

May Xiaoyan Bao

University of New Hampshire - Peter T. Paul College of Business and Economics ( email )

10 Garrison Avenue
Durham, NH 03824
United States

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3366 (Phone)

David B. Smith (Contact Author)

University of Nebraska at Lincoln - School of Accountancy ( email )

307 College of Business Administration
Lincoln, NE 68588-0488
United States

Emre Unlu

University of Nebraska at Lincoln ( email )

Lincoln, NE 68588
United States

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