Narrow Results

This study investigates the empirical relationship between the use of derivatives by Korean banks and risk. In doing so, we employ two alternative measures of proxy for firm risk: systematic risk and ex ante earnings volatility.

Contrary to the general concerns about the risk-increasing role of the use of derivative products, our results indicate that banks' derivatives are, on average, associated with two measures of risk in negative ways. The evidence is consistent with the conjectures that derivative use reduces noise related to exogenous factors and hence decreases firm risk. This suggests that equity market participants, on average, perceive derivative activities by banks as a sign of banks' efforts to reduce risk.

Corporate debt market is crucial to raise capital for businesses and to maintain steady economic growth. Disclosure with more complete accounting information provides more informative signals for investors to assess a firm’s risk of defaulting on its debt, which is the fundamental mechanism of the seminal theory by Duffie and Lando [2001, Term Structures of Credit Spreads with Incomplete Accounting Information, Econometrica 69(3), 633–664]. Using a disclosure quality measure that captures the completeness of accounting information in the income statement and balance sheet, we show that a firm’s default risk is significantly and negatively associated with the completeness of its accounting information. We further show that the negative relation is mainly driven by the information completeness of the balance sheet, relative to that of the income statement. In addition, the information completeness of the long-term liabilities on the balance sheet better explains a firm’s default risk, compared to the current liabilities. Overall, our findings provide new evidence on the importance of accounting information completeness for both firms and investors in the debt market.