Asymmetric Effects of Default Probability on Earnings Informativeness

I examine how the asymmetric persistence of good versus bad news earnings shapes the relation between a firm's default probability and the informativeness of its earnings for firm valuation. I extend earnings-persistence-based valuation theory to develop the study's key prediction that the negative relation between default probability and earnings informativeness is stronger for good news earnings than for bad news earnings. Using both firm-specific default probability estimates based on the Black-Scholes-Merton model, and the setting of intra-industry bankruptcy contagion to capture exogenous positive shocks to assessed default probability of surviving firms, I provide empirical evidence consistent with this central prediction. My analysis provides novel insights into the interactive dynamics of default probability and firm valuation, and extends our understanding of the effects of asymmetric earnings persistence on firm valuation