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The Relative and Incremental Explanatory Powers of Dirty Surplus for Debt Interest Rate

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Author Info

  • Akinobu Shuto

    (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)

  • Shota Otomasa

    (Faculty of Commerce, Kansai University, Japan)

  • Kazuyuki Suda

    (Graduate School of Finance, Accounting and Law, Waseda University, Japan)

Abstract

This study investigates the relationship between dirty surplus items on the balance sheet and the cost of debt for Japanese firms. We focus on three dirty surplus items-unrealized gains and losses on available-for-sale securities (SEC), foreign currency translation adjustment (FOC), and land revaluation surplus (LAND). While many previous studies on dirty surplus adopted the value-relevance perspective, we examine the effect of dirty surplus items on the interest rate spread of bonds from the contractual perspective. We use the Vuong (1989) test to evaluate the relative explanatory power of the equity ratio with and without dirty surplus items for the interest rate spread on bonds issued. We find evidence that the equity ratio with dirty surplus items is more strongly associated with the debt interest rate than that without dirty surplus items. The results suggest that the total amount of dirty surplus items have statistically significant explanatory power for the interest rate spread. However, some dirty surplus items do not have explanatory powers for the bond interest rate spread. While FOC has relative and incremental explanatory powers and SEC has only incremental explanatory power, LAND has neither relative nor incremental explanatory power for the bond interest rate spread. The results mean that FOC and SEC are useful to Japanese firms for bond contracting.

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Bibliographic Info

Paper provided by Research Institute for Economics & Business Administration, Kobe University in its series Discussion Paper Series with number 230.

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Length: 36 pages
Date of creation: Aug 2007
Date of revision: Mar 2008
Handle: RePEc:kob:dpaper:230

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Keywords: Dirty surplus items; Cost of deb; Relative information content; Incremental information content;

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