‘Unexpected Defaults: The Role of Information Opacity’
by Aytekin Ertan
London Business School
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Bond defaults are undesirable yet natural outcomes of risky investments. What is also crucial but hitherto underexplored is the unexpectedness of defaults. This notion is important because we observe that, compared to expected defaults, unexpected defaults are associated with worse recovery outcomes and more likely to adversely affect peer firms. We develop a parsimonious measure of default unexpectedness using bond price movements leading up to defaults. We next investigate the role of information opacity in this context and find that firms’ complex financial reporting language, opaque accounts, and weak voluntary disclosures increase default unexpectedness. From an external perspective, defaults occur more unexpectedly when rating agencies disagree with one another and when firms receive less media coverage. However, we also find instances in which opacity mitigates default unexpectedness—e.g., when transparency increases default unexpectedness by incentivizing investors to run. Overall, our paper introduces default unexpectedness as an economically relevant construct and highlight the role of corporate transparency in mediating unexpected defaults.