We study the role of borrower accounting quality in debt contracting. Specifically, we examine how accounting quality affects the borrower's choice of private versus public debt market and how the design of debt contracts vary with accounting quality in the two markets. We find that accounting quality affects the choice of the market, with poorer accounting quality borrowers preferring private debt, i.e., bank loans. This is consistent with banks possessing superior information access and processing abilities that reduce adverse selection costs for borrowers. We also find that accounting quality has an economically significant but differential impact on contract design in the two markets consistent with differences in recontracting flexibility across the two markets. In the case of private debt, since there is greater recontracting flexibility, both the price (i.e., interest) and non-price (i.e., maturity and collateral) terms are significantly more stringent for poorer accounting quality borrowers, unlike public debt where only the price terms are more stringent. The impact of accounting quality on interest spreads of public debt is 2.5 times that of the private debt, since the price terms alone reflect the variation in accounting quality.

We re-examine the existence of earnings announcement-day premia and find that they persist beyond the sample period used in prior studies (ending in 1988). The magnitude of the premia is lower for all sub-periods when we use the expected rather than actual announcement dates used in prior studies. Moreover, the premia are not present following earnings pre-announcements. Finally, we find that limits to arbitrage are a likely explanation for the continuing presence of the premia despite the fact that firms on earnings announcement dates have a significantly positive Jensen’s alpha and a higher Sharpe Ratio than on non-announcement dates.

We examine the contemporaneous relation between earnings forecast accuracy and recommendation profitability to assess the effectiveness with which analysts translate forecasts into profitable recommendations. We find that, after controlling for expertise, more accurate analysts make more profitable recommendations, albeit only for firms with value-relevant earnings. Next, we show that conflicts of interest from investment banking activities affect the relation between accuracy and profitability. In the case of buy recommendations, more accurate forecasts are associated with more profitable recommendations only for the nonconflicted analysts. For hold recommendations, higher levels of accuracy are associated with higher levels of profitability for conflicted analysts, provided these recommendations are treated as sells. Finally, we find that regulatory reforms aimed at mitigating analyst conflicts of interest appear to have improved the relation between accuracy and profitability. Specifically,the integrity of buy and hold recommendations has improved and the change is more pronounced for analysts expected to be most conflicted.

In this paper, we analyze how financial analysts generate information, make decisions about firm coverage, and try to maintain their forecasting accuracy after the passage of Regulation Fair Disclosure ("Reg FD"). Using the model developed by Barron, Kim, Lim, and Stevens 1998, we find that analysts are investing more effort in idiosyncratic information discovery. In order to do this, individual analysts appear to be reducing coverage for well-followed firms while increasing coverage of firms that were less followed prior to Reg FD. Analysts who had preferential links with firms that they covered, such as analysts from large brokerage houses, tend to have greater forecast accuracy in the pre-FD period. However, these analysts are unable to sustain their forecasting superiority in the post-FD period, which suggests that there has been a leveling of the information playing field among analysts. Overall, our results reflect a trend toward greater reliance on idiosyncratic information discovery on part of the financial analysts.

This study provides evidence on the impact of the Securities and Exchange Commission’s (SEC) Regulation Fair Disclosure (Reg. FD) on information asymmetry. Reg. FD prohibits firms from disclosing “material” information selectively to analysts and institutional investors. The regulation has triggered a debate on mainly three issues: (a) whether use of nonpublic channels for selective disclosure (such as, analyst conference calls) results in information asymmetry among investors, (b) whether prohibiting nonpublic communications is contributing to leveling of information asymmetry among investors, and (c) whether Reg. FD has caused firms to reduce the quality of their public voluntary disclosures. The present study addresses all of these issues. I use a sample of earnings conference calls and classify firms as either, (1) “open” firms, which always held conference calls accessible to all investors; or (2) “restricted” firms, which held conference calls for only analysts and institutional investors in the pre- Reg. FD period. I find that restricted firms faced higher information asymmetry compared to open firms in the pre- Reg. FD period. However, in the post- Reg. FD period the differences in information asymmetry between open and restricted firms do not persist. Taken together it suggests that selective disclosure was associated with higher information asymmetry among investors and Reg. FD seems to have contributed to the leveling of such information asymmetry. In additional tests, I do not find strong evidence that Reg. FD has caused firms to reduce quality of information conveyed in conference calls. The study adds to our understanding of how voluntary and mandated disclosure impact information asymmetry among investors.

We study the role of conservatism in reported net asset values of borrowers (defined as balance sheet conservatism) on private debt contracting. We hypothesize that conservative reporting of asset values provide lenders greater confidence in the collateral value of the firm’s assets and reduces the risk in the loan (Asset Value Hypothesis). Second, we hypothesize that reporting of conservative asset values constrains the borrower’s ability to reflect adverse economic events in net asset values in future. Therefore debt contracting efficiency is high only when the balance sheet conservatism is not high (Constraint Hypothesis). Using a sample of bank loans we study interest spreads, covenant intensity, covenant slack and reliance on financial covenants and find results consistent with our hypotheses. Our study sheds light on the effects of reporting conservative asset values on debt contracting.