Sell-Side Debt Analysts and Debt Market Efficiency

We explore sell-side debt analysts’ contributions to the efficiency of securities markets. We document that debt returns lag equity returns less when debt research coverage exists, which is consistent with debt analysts facilitating the process by which available information is impounded in debt prices. The effect of debt research on the debt market’s lag is incremental to, but comparable in magnitude to, hedge fund ownership’s effect. No such effect exists for credit rating agencies. We also find that the dissemination of debt reports has an immediate effect on return volatility in both markets, which is consistent with debt analysts providing new information to securities markets. Increased return covariation suggests that this information impacts the pricing of debt and equity in the same direction. A large percentage of debt reports do not induce any immediate debt market return reaction but do induce an equity return reaction, which is consistent with new information being provided despite the absence of a debt market reaction. Finally, there is a systematic variation in the debt market’s trading and return reactions to debt research. Timely reports and those by high-reputation brokers induce a quicker trading response, thus enhancing liquidity, whereas only timely reports induce a greater return response. This study illuminates the institutional underpinnings of debt market efficiency, and it has important implications for information content tests in the debt market, where trading is limited. This paper was accepted by Mary Barth, accounting.