Internal control quality and credit default swap spreads

Dragon Yongjun Tang, Feng Tian, Hong Yan

Research output: Journal article publicationJournal articleAcademic researchpeer-review

11 Citations (Scopus)

Abstract

This paper presents the first study on the effects of internal control quality on derivatives pricing. Specifically, we utilize data from the credit default swap (CDS) transactions of well-monitored companies to examine the relationship between the quality of internal control and the cost of debt. CDS data are advantageous for the study of this relationship because CDS contracts are comparatively more homogeneous, standardized, and liquid than either bank loans or public bonds. We find that, all else being equal, companies experiencing internal control material weakness (MW) exhibit higher CDS spreads than companies with effective internal control. Moreover, the MW effect on CDS spreads is more pronounced for company-level MWs than for less severe, account-specific MWs. We also document that CDS spreads increase around the filings of MWs. Furthermore, the deterioration of internal control quality is related to increases in CDS spreads. Finally, short-maturity CDS spreads are more affected by MWs than are long-maturity CDS spreads.
Original languageEnglish
Pages (from-to)603-629
Number of pages27
JournalAccounting Horizons
Volume29
Issue number3
DOIs
Publication statusPublished - 1 Jan 2015

Keywords

  • CDS
  • Cost of debt
  • Credit default swaps
  • Derivatives pricing
  • Internal control over financial reporting
  • Material weaknesses
  • SOX 404

ASJC Scopus subject areas

  • Accounting

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