Earnings Response Coefficients and Default Risk: Case of Korean Firms

Abstract

This study examines how firm's default risk affects the earnings response coefficient (ERC). If accounting earnings provide firm’s informativeness, the ERC of the firms highly associated with the default risk. The reason for this is that the firm’s bankruptcy risk determines the mechanism allocating wealth changes from unexpected earnings between shareholders and bondholders. Based on that, I investigate the changes of ERCs comparing with the issue of bond and the redemption of issued bond, using a sample of 128 firms in the Korean Stock Exchange (KSE) during 2000-2007 periods. The empirical results indicate that the ERCs decrease for the issue of new bond, whereas increase for the redemption of issued bond, after controlling the market beta and firm’s growth ratio. Overall, the findings provide directly support that the ERC is a negatively related to the firm's default risk as measured by financial leverage.