Abstract
Purpose The purpose of this paper is to investigate two research questions: do accounting reports provide information that helps bondholders assess credit risk of financial institutions? What are the relevant accounting variables related to financial institutions' credit spreads?
Design/methodology/approach The authors estimate all models of credit spread by specifying fixed effects with year dummies.
Findings The authors' document that financial institutions' cash flows and loan loss provisions (LLP) are significantly correlated with bond spreads. The authors observe that an increase in nondiscretionary LLP predicts an increase in credit spreads, as the former reflects a higher default risk. Bondholders also react negatively to an increase in discretionary LLP, viewed as evidence that a financial institution is engaged in opportunistic earnings or tax management. Finally, the authors demonstrate that the relationship between accounting data and credit spreads is stronger for high-yield bonds than for low-yield bond.
Research limitations/implications This study has certain limitations due to the sample size and data frequency.
Practical implications First, this paper provides strong evidence to all market participants that financial accounting reports are useful in forecasting credit risk in emerging markets. Second, the paper highlights the importance of disclosure policies and accounting transparency of financial institutions in emerging markets. Third, the results are also of practical interest to standard setters and financial regulators. The latter should consider monitoring accruals, especially the discretionary component of LLP, to mitigate the effects of accounting manipulations and managers' opportunism.
Originality/value First, the previous literature does not focus on financial institutions despite their key role in the economy. Second, the paper is the first to study the credit relevance of accounting information in emerging markets (Tunisia).