Default Prediction Around the World: International Evidence on the Role of Corporate Transparency and Market Frictions

We document significant heterogeneity across countries in the ability to assess a firm’s likelihood of default using marketand accounting-based sources of default risk information. Surprisingly, for some countries, we find that a default prediction model based solely on public financial reporting information outperforms a model based solely on market variables. Our evidence suggests that variation in the predictive ability of market-based variables across countries is primarily attributable to the existence of capital market frictions, such as short sale constraints, which prevent the incorporation of information into prices, rather than the availability of information. Finally, we document that direct incorporation of accounting information into the default prediction model largely offsets the loss in overall predictive accuracy created by market frictions, especially in countries with high corporate transparency. _______________________________ Financial support from the University of Chicago Booth School of Business and the University of Rochester Simon School of Business is gratefully acknowledged. We are grateful for comments received from Bill Beaver, Mike Minnis, Shiva Rajgopal, and workshop participants at Emory University. * Corresponding author. Tel.: +17737029656; [email protected].