Title: Risky debt and the earnings response coefficient: a reexamination in the presence of illiquid growth opportunities

Authors: Zhaoyun Shangguan

Addresses: Department of Accounting and Finance, The Charlton College of Business, University of Massachusetts – Dartmouth, 285 Old Westport Road, North Dartmouth, MA 02747, USA

Abstract: Prior literature has documented that risky debt reduces the Earnings Response Coefficient (ERC) by inducing higher equity risk and default risk. This paper reexamines the role of debt in explaining the ERC in the presence of illiquid growth opportunities, a factor that has largely been ignored in prior research. Specifically, it documents that the negative marginal effect of debt on the ERC is mitigated by illiquid growth opportunities because they may reduce the firm|s equity risk and default risk by inducing a risk-aversion incentive. This research addresses the widespread existence of illiquid growth opportunities in firms as the economy has grown increasingly intangible.

Keywords: earnings response coefficient; ERC; risky debt; illiquid growth opportunities; risk aversion incentives; equity risk; default risk.

DOI: 10.1504/IJBIR.2007.013727

International Journal of Business Innovation and Research, 2007 Vol.1 No.4, pp.404 - 424

Published online: 23 May 2007 *

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