Financial Reporting Quality and Dual-Holding of Debt and Equity

Abstract

I investigate whether the financial reporting quality (FRQ) of a firm influences the propensity of institutional investors to simultaneously hold the firm’s debt and equity (i.e., dual-holders). I predict that the underlying reason for institutional dual-holding in firms with low FRQ is access to better information that is available only to lenders. Accordingly, I find that dual-holders are more likely to participate in firms with low FRQ. I predict that dual-holders trade on the additional information received from the borrower. Consistent with this prediction, I find that dual-holders achieve excess returns of 8% on their trades in the borrower’s equity, and the direction of their trades predicts the direction of borrowers’ news on earnings announcement day. Finally, I demonstrate that dual-holders’ trades generate excess returns only in firms with low FRQ, suggesting that investors become dual-holders in firms with low FRQ because informed trades in such firms offer higher returns.

Keywords: dual-holding, financial reporting quality, syndicated loans, informed trading

JEL Classification: G14, M41