Abstract
This study examines how the disclosure of fraudulent reporting affects bondholder wealth, credit ratings, and contract features of new bond issues. I find that fraud announcements trigger swift, sharp, and long lasting credit rating downgrades and are associated with significant declines in bondholder wealth. An examination of new bond issues confirms a significant increase in both the yield spread and the gross spread charged by the investment bank compared to pre-fraud levels. Moreover, a significant proportion of bonds issued after a fraud contain call provisions that are more expensive in the short run but may be potentially value maximizing in the long run if credit conditions improve. Thus, I argue that managers are optimistic that the increase in the cost of debt induced by the fraud is temporary. However, contrary to managers’ optimistic beliefs, I find that corporate credit ratings, once decreased, remain significantly depressed for at least three years following the fraud announcement.
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