Unexpected defaults: the role of information opacity

Ertan, A, Lee, Y and Wittenberg-Moerman, R (2024) Unexpected defaults: the role of information opacity. Review of Accounting Studies. ISSN 1380-6653 (In Press)

Abstract

Bond defaults are undesirable yet natural outcomes of risky investments. What is also crucial but hitherto underexplored is the unexpectedness of defaults. We develop a parsimonious measure of default unexpectedness and highlight its economic importance by demonstrating that unexpected defaults are associated with unfavorable recovery outcomes and adverse price changes in peer firm bonds. We then examine how default unexpectedness relates to information opacity. We find that firms with opaque financial reporting and weak voluntary disclosure experience more unexpected defaults. Defaults also occur more unexpectedly when the external information environment is opaque—when rating agencies disagree on a firm’s credit risk and when the media coverage is low. We further report evidence on a specific case in which transparent firms suffer unexpected defaults—when creditors’ run incentives are particularly high. Overall, our paper introduces default unexpectedness as an economically relevant construct, offers a tractable measure, and highlights the role of transparency in mediating this phenomenon.