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Accrual quality , bond liquidity , and cost of debt

This paper investigates the effect of accrual quality on bond liquidity and the implications of this effect for cost of debt. We argue that high accrual quality not only reduces information asymmetry but also decreases uncertainty, thereby improving liquidity, which in turn lowers the cost of debt. We first document that higher accrual quality is associated with higher bond liquidity. We then show that accrual quality reduces cost of debt but this effect is subsumed by liquidity, suggesting that the effect of accrual quality on reducing cost of debt arises largely through its effect on improving bond liquidity. Further analyses reveal that our primary results are robust to controlling for information asymmetry (through PIN), suggesting that our documented effect arises through aspects of liquidity that are independent of information asymmetry. We also show that credit ratings reflect the underlying structural relations among accrual quality, bond liquidity and cost of debt, albeit in an incomplete manner.