Spillover effects of credit default swaps on corporate disclosure along the supply chain

Abstract

We investigate the effect of customers’ credit default swap (CDS) referencing on suppliers’ issuance of management forecasts. We argue that customers’ CDS referencing increases the suppliers’ business volatility, making forecasting more difficult. 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. By using a difference-in-differences design, we find consistent evidence that firms tend to reduce their frequency of forecast issuance after the initiation of sales to CDS-referenced customers, compared to firms without CDS-referenced customers. 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). Further analysis shows that the information channel seems to be the main mechanism for our findings. Finally, we find the negative relationship between the supplier’s management forecast issuance and its exposure to CDS-referenced customer firms is driven by good news forecasts, possibly due to the higher litigation risk associated with disclosing good news and withholding bad news. Our findings add to the literature examining the spillover effects of CDSs on entities outside those directly referenced by CDSs.