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Journal of Corporate Finance Vol. 75 2022

Credit default swaps and corporate performance smoothing

Wei-Shao Wu1; Robert C. W. Fok2; Yuanchen Chang3; Chao-Jung Chen4

1 University of Electronic Science and Technology of China · 2 University of Wisconsin–Parkside · 3 National Chengchi University · 4 National Pingtung University

Abstract

This study examines whether the availability of traded credit default swaps (CDS) influences the referenced firms' incentive to smooth their performance. We show that with the introduction of CDS trading on their debt, CDS-referenced firms (CDS firms) lower both their earnings and cash flow volatility. Specifically, earnings volatility declines faster than cash flow volatility, which is consistent with income smoothing behavior. The effect of CDS trading on performance smoothing is qualitatively similar under different market and economic conditions. These results support the notion that CDS firms smooth their performance to avoid renegotiation with CDS-protected creditors. We also find that CDS firms smooth their cash flows via hedging with derivatives and smooth their earnings using discretionary accruals after the inception of CDS trading.

DOI
10.1016/j.jcorpfin.2022.102238
Volume
75
Pages
102238
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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