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Accounting Department's Lecture

Topic:    Incremental Usefulness of Parent-only Balance Sheets to Debt holders:Evidence from Banks

Speaker:Jigao Zhu

Time:      11:30 Nov.15 2017

Place:     Room706,Mingde Bussiness Building

Abstract:

Under the U.S. GAAP, general-purpose financial statements are prepared for the consolidated reporting entity, aggregating information of the parent company and any subsidiaries over which the parent has control. Debt contracts are written on a legal entity rather than on a consolidated reporting entity. A parent and its subsidiaries are separate legal entities and are not responsible for each other’s debt unless there are full guarantee agreements between the parent and its subsidiaries. In this study we examine whether the parent-only balance sheet is incrementally useful to the parent’s debtholders beyond the consolidated balance sheet. We obtain evidence from a sample of banks, which provide parent-only financial statements to bank regulators and make the statements publicly available. We find that the parent-only financial leverage is incrementally positively associated with the premium of credit default swaps (CDS)—the price of the parent company’s default risk—after controlling for the consolidated leverage. In addition, the parent-only leverage is incrementally positively associated with the volatility of CDS premia subsequent to the reporting of parent-only balance sheets. Furthermore, we find that the parent-only leverage is more useful for firms with lower credit ratings. We also find that the incremental explanatory power of the parent-only leverage is weakest for the fourth fiscal quarter perhaps because 10-K reports often already provide more debt information than quarterly reports. Overall, our evidence supports the idea of supplementing consolidated financial statements with parent-only statements or other information about the parent’s credit risk.