Externalities of Credit Default Swaps on Corporate Disclosure

Abstract

In this paper, we investigate the effect of customers' CDS referencing on suppliers' management forecasting activity. We argue that customers' CDS referencing increases the suppliers' business volatility and thus earning forecasting difficulty. At the same time, the information from customers' CDS market reduces investors' demand for the suppliers' disclosure and induces the suppliers to scale back their own disclosure. We find consistent evidence that firms that derive a greater proportion of their revenue from CDS-referenced customers tend to reduce their frequency of forecast issuance. This relationship is stronger when the supplier's business relies more on CDS-referenced customers (thus strengthening the effect of customer CDS referencing on suppliers' forecasting difficulty). In comparison, the relationship is weaker when customers have more analyst following (thus resulting in less incremental information produced by customer CDS referencing). Our findings suggest the spillover effects of customer CDS on supplier's disclosure along supply chains.