Does the CDS Trading Improve Managerial Learning from Outsiders?

As the Credit Default Swap (CDS) market has come under increasing scrutiny, it is important to understand the costs and benefits of the introduction of the CDS trading. This study examines the effect of the CDS trading on managerial learning when managers of reference entities make investment decisions. We measure managerial learning as the investment-to-price sensitivity in Chen et al. (2007) and find that the initiation of the CDS trading enhances managerial learning, suggesting that CDS trading improves the informativeness of stock prices to managers. We also find that the increase in the sensitivity is more pronounced for firms with low analyst following and low institutional ownership, and for firms in non-high-tech industries and in the mature or stagnant stages of life-cycle. Consistent with information flows from the CDS market to the equity market being most likely for firms experiencing credit deterioration, we find that increases in managerial learning are more evident for firms with a higher leverage and a lower credit rating. Our findings provide large-sample evidence on the positive consequences of CDS trading in the context of inside managers’ ability to learn from outside investors or the market.