The Effect of Accruals Quality on Credit Rating and Cost of Debt －Focus on the Innate and Discretionary of Accruals Quality－
Asian Tax Journal Vol. 19 No. 4 (2018), pp. 9-48
Abstract
This study investigate whether credit rating agencies and debtholders take into account accruals quality (hereafter, AQ), a proxy for the information risk associated with earnings quality. Also, this paper distinguishes accruals quality driven by economic fundamentals (innate AQ) versus management discretion (discretionary AQ) following Francis et al. (2005) and investigates whether accruals quality affect credit rating and cost of debt differently depending on the source of AQ. Accruals quality (AQ) is measured by the extent to which total current accruals accurately map into operating cash flow realizations. This approach was originally developed by Dechow and Dichev (2002) and modified by McNichols (2002). That is, accruals quality tells investors about the mapping of accounting earnings into cash flows. Relatively poor accruals quality weakens this mapping and, therefore, increases information risk. Therefore, measuring accruals quality (AQ) as the standard deviation of residuals from regressions relating current accruals to cash flows, this paper expected that poorer AQ is associated with lower credit rating and larger costs of debt. For the analysis, this paper measure credit rating information comes from KISVALUE. The corporate credit ratings have from 1 point to 10 points. 10 point represents firms with the best credit rank and 1 points represents firms with the worst credit rank (Park and Nam 2010). Following the prior studies (e.g., Park and Kim 2013；Park and Yoon 2013 etc.), this paper employ the average interest rates and the yield spread of interest rates as proxies for the cost of debt. Also, following Francis et al. (2005) to estimate AQ and its both components (innate AQ vs. discretionary AQ) as a proxy of earnings quality. This paper examine all listed firms (KOSPI and KOSDAQ listed firms) in the Korean stock market with available corporate credit ratings and cost of debt. Therefore, this study uses the total 15,090 firm－year observations for the period from 2003 to 2015. The empirical findings of this paper are following. First, after controlling for several factors that affect credit rating and cost of debt, there are a statistically significantly negative association between credit rating and AQ, and also significantly positive association between cost of debt and AQ at 1% level respectively. This results show that the relatively poor accruals quality pricing effect are related to information risk associated with earnings. Second, this paper also distinguish between total accruals quality driven by economic fundamentals (innate AQ) versus management choices (discretionary AQ), find that both components have significant effects on credit rating and cost of debt respectively, but innate AQ effects are significantly larger than discretionary AQ effects. This result implies that both credit rating agencies and debtholders’ response varies with the source of accruals quality. This study is different in that we examine direct relation between credit rating and cost of debt and information risk measured as accruals quality, as well as the innate and discretionary components of accruals quality using Korean data. Overall. the results of this study suggest that the credit rating agencies and creditors appreciate accruals quality and its components in listed firms. Thus, the findings of this study contribute to the related literature on the relationship between accruals quality and market reaction by providing empirical results. Also, this study contributes to provide useful information related to accruals quality, a proxy for the information risk associated with earnings quality to scholars as well as practitioners, investors, and regulators. Furthermore, researchers who are interested in this area can also apply the discussion in this paper for the related studies.
Keywords
- Accruals quality
- Innate accruals quality
- Discretionary accruals quality
- Information risk
- Credit rating
- Cost of debt
Related Articles
The Influence of Overvalued Equity on Overinvestment and its Relation to Financial Reporting Quality’s Effect
22(2) 91-132
The Effect of Smoothing of GAAP Effective Tax Rates on Credit Ratings and the Cost of Debt
21(5) 9-57
Tax Avoidance and Corporate Transparency
20(2) 95-123
The Effect of Tax Risk and Tax Avoidance on Credit Rating and Cost of Debt
20(2) 163-204
The Effect of the Information Content of Earnings after Mandatory IFRS Adoption on Financial Analysts’ Earnings Forecast Accuracy
19(3) 119-163