Spillover Effects of Credit Default Swaps on Corporate Disclosure along the Supply Chain

Abstract

We investigate the effect of customers’ CDS referencing on suppliers’ management forecasting activity. We argue that customers’ CDS referencing increases the suppliers’ business volatility and thus forecasting difficulty, and at the same time, the information from customers’ CDS market reduces investors’ demand for the suppliers’ disclosure and induces the suppliers to scale back their own disclosure. We find consistent evidence that firms that derive a greater proportion of their revenue from CDS-referenced customers tend to reduce their frequency of forecast issuance. This relationship is stronger when the supplier’s business relies more on CDS-referenced customers (thus strengthening the effect of customer CDS referencing on suppliers’ forecasting difficulty), while the relationship is weaker when customers have more analyst following (thus resulting in less incremental information produced by customer CDS referencing). Further analysis shows that the negative relationship between forecasting activity and exposure to CDS-referenced customer firms is driven by good news forecasts, possibly due to the higher litigation risk associated with disclosing good news and withholding bad news. Our findings add to the literature examining the spillover effects of CDSs on entities outside those directly referenced by CDSs.

Keywords: corporate disclosure; credit default swaps; customer-supplier relationship; externalities

JEL Classification: M41, L14