Previous empirical research on informativeness of earnings hasfocused on stockholders, and has not examined earnings informativenessfor stockholders and bondholders. Stockholders are residual claimantsand bondholders are fixed claimants, the informativeness of earningsshould differ for these two types of investors. When firm is financiallystrong, earnings changes should be of limited relevance to bondholders,but should be relevance to bondholders. In contrast, as the likelihood offinancial distress increase, stockholder’s limited liability allows them toabandon the firm to bondholder and earnings change should beincreasingly important to bondholders and less important to shareholdersbecause earnings provide information on firm value. This suggest that theeffect of earnings to stock return should decrease as the firm’s financialstrength declines, while the effect of earnings to bond return shouldincrease. In contrast, when firm’s financial condition is strong, the effect ofearnings to stock return is higher than the effect of earnings to bondreturn. We refer to this as the liquidation option hypothesis.The objective of this study is to examine liquidation optionhypothesis. We use bond rating as financial condition’s measurement.Consistent with our hypotheses, we find that the effect of unexpectedearnings to stock return is significant when firm is financially strong butthe effect of unexpected earnings to bond return is not significant. Whenfinancial distress increase, the effect of unexpected earnings to stockreturn is not significant but the effect of unexpected earnings to bondreturn is significant
Copyrights © 2008