Does the Variability of Other Comprehensive Income (OCI) Play a Role in the Determination of Cost of Debt, Capital Structure and Credit Ratings?

descriptionPublicationkeyboard_double_arrow_right Article , Other literature type 01 Jan 2017 English Publisher:Elsevier BVJournal:SSRN Electronic Journal (eissn: 1556-5068,

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Authors: May Xiaoyan Bao; Emre Unlu;

doi: 10.2139/ssrn.2939958

Does the Variability of Other Comprehensive Income (OCI) Play a Role in the Determination of Cost of Debt, Capital Structure and Credit Ratings?

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Abstract

We examine the usefulness of other comprehensive income (OCI) to debt investors in nonfinancial companies. Motivated by Merton’s (1974) real options framework, we construct a measure of incremental OCI volatility, designed to capture the effect of OCI on overall firm asset volatility, which is a primary driver of credit risk in Merton’s (1974) model. We find that the volatility of incremental OCI influences the likelihood of default, credit ratings, and the cost of debt. Overall, our evidence suggests that creditors use information from OCI in their assessment of firm credit risk and in pricing debt contracts.

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