We investigate whether accounting conservatism can be explained as a rational response to ambiguity. Decision analysis shows that decision rules that work well under ambiguity put greater weight on negative than on positive outcomes, i.e., exhibit caution. Accounting conservatism increases the timeliness of bad news that is more relevant under cautious decision rules and thereby helps corporate managers and investors implement them. We, therefore, hypothesize that firms facing greater ambiguity report more conservatively. We adopt two different measures to proxy for the firm-specific level of ambiguity. First, we identify firms pursuing the “prospector” versus “defender” business strategies. Compared with defenders, who focus on utilizing existing resources, prospectors actively create their future by seeking new business opportunities and thus face greater ambiguity. Second, we conduct an additional set of tests based on environmental scanning, which reduces ambiguity. Both sets of results suggest that firms facing greater ambiguity report more conservatively.

This study examines the effect of bank loan monitoring on public bond contract design. We find that bond yield spreads are lower and that bond issuance amounts are larger when a borrower has recently obtained a private loan, consistent with bond issuers benefiting from the screening and ongoing monitoring of banks. We find that these bonds include more covenants than bonds issued without the cross-monitoring of banks, consistent with bondholders wanting to protect themselves from private lenders. This effect is larger for firms with high information asymmetry and larger potential conflicts between different lender types. Our results are robust to a battery of sensitivity tests. Overall, our empirical results suggest that borrowers that precede their public bond issuances with private loan agreements receive more favorable bond terms. Meanwhile, these benefits are associated with the cost of increased monitoring by public bonds.

This study examines the relevance of modified audit opinions (MAO) in private debt contracting. We use the auditor׳s explanatory language to partition MAOs into Inconsistency opinions, resulting from an accounting change or a restatement; and Inadequacy opinions, arising from a material uncertainty or a going concern (GC) opinion. Using the loan contracts of firms with MAOs, we find that, compared with loans issued in the year after a clean opinion, loans issued in the year after an MAO are associated with higher interest spreads (17 basis points on average), fewer financial covenants, more general covenants, smaller loan sizes, and a higher likelihood of requiring collateral. We find that the effect on loan spreads (as well as on other non-price terms) varies by the type of MAO, ranging from no effect for an accounting change to an average increase of 107 basis points for a GC opinion. Additional analyses of GC opinions find that auditors communicate incremental information to lenders about clients’ credit risk. Overall, our empirical results suggest that lenders incorporate the information contained in MAOs into debt contracting.

A recent trend is that firms prefer to hire generalist CEOs with transferable skills (across firms or industries) over hiring specialist CEOs, but the consequences of this trend are unclear. In this study, we examine whether credit rating agencies consider a CEO's general skills as a credit risk factor when assessing an entity's overall creditworthiness. We predict and find that generalist CEOs are associated with lower credit ratings, suggesting that the presence of generalist CEOs is a significant credit rating factor. We also find that generalist CEOs are likely to take on more risks, which leads to more volatile performance ex post, and our path analyses confirm default risk is a significant mediator between credit ratings and CEOs' general skills. Our results hold in the presence of additional controls (e.g., CEO characteristics and corporate governance), when applying different fixed‐effect models and different matching methods, and for a subsample with forced CEO turnover. We also find that the negative relationship is attenuated for R&D‐intensive firms and firms in competitive industries. Last, we provide evidence that firms with generalist CEOs face higher borrowing costs, such as bond yields and syndicated loan spreads. Overall, our results contribute to a growing literature on the costs and benefits of hiring generalist CEOs, by providing a full picture of why hiring a generalist CEO may benefit shareholders but also cause misalignments with bondholders' interests.