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Building upon recent research which indicates that debt markets rather than equity markets shape financial reporting, this study examines how conditionally conservative financial reporting relates to the yield spread of corporate bond issues. Our findings suggest that the debt contract efficiency/information costs view of conditional conservatism, documented in private debt contracts, does not generalize to public debt contracts. Instead, a debt contract renegotiation costs perspective seems to better capture the dynamics of the public debt markets, with conditionally conservative reporting being associated with higher yield spread of corporate bond issues. Additional subsample test results indicate that the association between conditional conservatism and bond yield spreads is more pronounced in non-investment grade bonds, for bond issuers with more financial distress, and for bonds that are issued before the passage of the Sarbanes–Oxley Act. This study fills a gap in the conservatism literature, which focuses primarily on equity or private bank loan markets with traditional debt contract efficiency/information costs view.

This paper surveys the recent literature on sovereign debt and relates it to the evolution of the legal principles underlying the sovereign debt market and the experience of the most recent debt crises and defaults. It finds limited support for theories that explain the feasibility of sovereign debt based on either external sanctions or exclusion from the international capital market and more support for explanations that emphasize domestic costs of default. The paper concludes that there remains a case for establishing institutions that reduce the cost of default but the design of such institutions is not a trivial task.

Theory posits that managerial holdings of debt (\"inside debt\") align managers' incentives with those of outside debtholders. Executive pensions, consisting of rank-and-file (RAF) plans and supplemental executive retirement plans (SERPs), and other deferred compensation (ODC) have debt-like payoffs, and could therefore function as inside debt. However, whereas SERPs are often unfunded and unsecured, RAF plans are funded and secured to some extent, and ODC may be invested in equity and withdrawn flexibly before retirement. Special arrangements in executive debt-like compensation could hence weaken or even nullify any incentive-alignment effect. We find that higher CEO debt-like compensation leads to lower promised yield and fewer covenants in a sample of loans originated in 2006-2008. This effect is driven entirely by benefits accrued under SERPs, consistent with SERPs more closely resembling risky corporate debt; balances accrued under RAF and ODC plans do not provide similar effects. Furthermore, promised yields are lower when debt-like compensation claims can be withdrawn only after outside debt claims are expected to settle. Our findings persist after accounting for endogeneity using state personal income tax rates as an instrument for CEOs' willingness to defer compensation. Overall, the evidence suggests that executive debt-like compensation is only effective at resolving stockholder-debtholder conflicts when its payoffs are truly debt-like and that lenders' perceptions are affected not only by the magnitude of debt-like compensation but also by its seniority. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1813 . This paper was accepted by Wei Jiang, finance .

When will solidarity, which emerges spontaneously from the fear of spillovers, be reinforced through contracting? The optimal pact between countries that differ substantially in their probability of distress is a simple debt contract with market financing, a borrowing cap, but no joint liability. While joint liability augments total surplus, the borrowing country cannot compensate the deep-pocket guarantor. By contrast, the optimal pact between two countries symmetrically exposed to shocks with an arbitrary correlation is a simple debt contract with joint liability, provided that shocks are sufficiently independent, spillovers sufficiently large, liquidity needs moderate, and available sanctions sufficiently tough.

Why do some firms, especially financial institutions, finance themselves so shortterm? We show that extreme reliance on short-term financing may be the outcome of a maturity rat race: a borrower may have an incentive to shorten the maturity of an individual creditor's debt contract because this dilutes other creditors. In response, other creditors opt for shorter maturity contracts as well. This dynamic toward short maturities is present whenever interim information is mostly about the probability of default rather than the recovery in default. For borrowers that cannot commit to a maturity structure, equilibrium financing is inefficiently short-term.

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.

Building on contract theory, we argue that financial covenants control the conflicts of interest between lenders and borrowers via two different mechanisms. Capital covenants control agency problems by aligning debt holder-shareholder interests. Performance covenants serve as trip wires that limit agency problems via the transfer of control to lenders in states where the value of their claim is at risk. Companies trade off these mechanisms. Capital covenants impose costly restrictions on the capital structure, while performance covenants require contractible accounting information to be available. Consistent with these arguments, we find that the use of performance covenants relative to capital covenants is positively associated with (1) the financial constraints of the borrower, (2) the extent to which accounting information portrays credit risk, (3) the likelihood of contract renegotiation, and (4) the presence of contractual restrictions on managerial actions. Our findings suggest that accounting-based covenants can improve contracting efficiency in two different ways.

This article analyzes the dynamic coordination problem among creditors of a firm with a time-varying fundamental and a staggered debt structure. In deciding whether to roll over his debt, each maturing creditor is concerned about the rollover decisions of other creditors whose debt matures during his next contract period. We derive a unique threshold equilibrium and characterize the roles of fundamental volatility, credit lines, and debt maturity in driving runs. In particular, we show that when fundamental volatility is sufficiently high, commonly used measures such as temporarily keeping the firm alive under runs and increasing debt maturity can exacerbate rather than mitigate runs.

Using a measure of contract strictness based on the probability of a covenant violation, I investigate how lender-specific shocks impact the strictness of the loan contract that a borrower receives. Banks write tighter contracts than their peers after suffering payment defaults to their own loan portfolios, even when defaulting borrowers are in different industries and geographic regions from the current borrower. The effects persist after controlling for bank capitalization, although bank equity compression is also associated with tighter contracts. The evidence suggests that recent defaults inform the lender's perception of its own screening ability, thereby impacting its contracting behavior.

We find that repeated borrowing from the same lender translates into a 10—17 bps lowering of loan spreads and that relationships are especially valuable when borrower transparency is low. These results hold using multiple approaches (propensity score matching, instrumental variables, and treatment effects model) that control for the endogeneity of relationships. We also provide a demarcation line between relationship and transactional lending. Spreads charged for relationship loans and nonrelationship loans are statistically identical if the borrower is in the largest 30% by asset size; has public rated debt; or is part of the S&P 500 index. Past relationships reduce collateral requirements and are also associated with obtaining larger loans. Our results imply that, even for firms that have multiple sources of outside financing, borrowing from a prior lender obtains better loan terms.