Credit Default Swaps and Managers’ Voluntary Disclosure

TLDR

CDSs enable lenders to hedge credit risk, reducing their incentive to monitor borrowers. The study examines how traded CDS availability influences firms’ voluntary disclosure, hypothesizing that reduced lender monitoring prompts shareholders to demand more disclosure from managers. Results show that firms with traded CDS contracts issue earnings forecasts more frequently, with stronger effects when lenders can hedge more and when institutional ownership and governance are higher, indicating that CDS availability prompts firms to increase voluntary disclosure to compensate for reduced lender monitoring.

Abstract

ABSTRACT We investigate how the availability of traded credit default swaps (CDSs) affects the referenced firms’ voluntary disclosure choices. CDSs enable lenders to hedge their credit risk exposure, weakening their incentives to monitor borrowers. We predict that reduced lender monitoring in turn leads shareholders to intensify their monitoring and demand increased voluntary disclosure from managers. Consistent with this expectation, we find that managers are more likely to issue earnings forecasts and forecast more frequently when traded CDSs reference their firms. We further find a stronger impact of CDS availability on firm disclosure when (1) lenders have higher ability and propensity to hedge credit risk using CDSs, and (2) lender monitoring incentives and monitoring strength are weaker. Consistent with an increase in shareholder demand for public information disclosure induced by a reduction in lender monitoring, we find a stronger effect of CDSs on voluntary disclosure for firms with higher institutional ownership and stronger corporate governance. Overall, our findings suggest that firms with traded CDS contracts enhance their voluntary disclosure to offset the effect of reduced monitoring by CDS‐protected lenders.