Asymmetric timely loss recognition, private debt markets, and underinvestment: evidence from the collapse of the junk bond market

This paper uses the collapse of the junk bond market in the early 1990s as a natural experiment to examine the effect of asymmetric timely loss recognition (ATLR) on speculative-grade (SPG) firms' access to private debt markets and underinvestment. For a sample of 450 firm-years over the period 1988-1991, I find that SPG firms that recognize economic losses in a timelier fashion experience a smaller reduction in debt financing and investment from the pre- to post-collapse period relative to SPG firms that recognize economic losses in a less timely fashion. I also document that the effect of ATLR on debt financing and investment is more pronounced for SPG firms that lack collateral and are not followed by sell-side equity analysts. These findings support the notion that ATLR improves a firm's ability to access private debt markets, thereby attenuating underinvestment. They also suggest that both collateral and sell-side equity analysts serve as substitutes for ATLR to facilitate SPG firms' access to private debt markets. Further analyses reveal that ATLR increases for SPG firms from the pre- to post-collapse period and this increase is more pronounced for SPG firms with net issuance of debt. This evidence suggests that firms adjust ATLR to obtain debt financing in response to private lenders' demand for it.