Accounting-based expected loss given default and debt contract design

Dan Amiram*, Edward Owens

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

We investigate an unexplored channel—loss given default (LGD)—through which accounting information can shape the design of debt contracts. Using a sample of defaulted bonds, we find that borrower accounting information available at contract initiation possesses significant power for predicting realized LGD at the subsequent default date. We then use this model to construct an accounting-based measure of expected LGD at the contracting date for a large sample of bond issuances. We find that this measure is positively associated with issuance date interest spread and covenant use, and document that these relations are not artifacts of an association between LGD and probability of default. We then show that accounting-based expected LGD has a stronger association with issuance date spread when the borrower’s underlying accounting is more conservative and when the accounting-based LGD predictors are more persistent. Our results increase our understanding of both the informational role and contracting role of accounting information.

Original languageEnglish
Pages (from-to)2437-2467
Number of pages31
JournalReview of Accounting Studies
Volume29
Issue number3
DOIs
StatePublished - Sep 2024

Funding

FundersFunder number
University of North Carolina at Chapel Hill
Razi Avram
Ohio State University
Stanford University
University of Chicago
MIT, New York University
Duke University
Columbia University, Dartmouth College
North Carolina State University
Emory University
University of Virginia
Tel Aviv University
University of Michigan
University of Pennsylvania

    Keywords

    • Accounting properties
    • Debt contracts
    • G12
    • Loss given default
    • M40
    • M41
    • Stepwise regression

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