3 Data Description
Our dataset is an unbalanced quarterly panel for 918 publicly-traded Compustat firms
in the U.S. nonfarm nonfinancial corporate sector from 1997Q1 to 2003Q3 (27 quar-
ters).8 The distinguishing feature of firms in our sample is that a significant part of
their long-term debt is in form of bonds that are actively traded in the secondary
market. For these firms, we have linked market prices of their outstanding securities
and market-based measures of default risks to Compustat’s balance sheet statements.
We now turn to the construction of our key variables: leverage, credit spreads, and
expected probabilities of default.
3.1 Sources and Methods
Leverage. Our measure of the firm’s leverage is constructed using Compustat balance
sheet information. Leverage is defined as the ratio of the book value of long-term debt
(all debt obligations due in more than one year from the firm’s balance sheet at the
end of the quarter) to the market-value of common equity.9 We use the book value
of debt, as opposed to the market value, because the book value is the amount that
the firm must repay. Market capitalization is computed by multiplying the number
of common shares outstanding by the closing stock price, both measured at the end
of the quarter.
Credit spreads. Daily market prices of corporate bonds were obtained from the Mer-
rill Lynch database that includes prices of dollar-denominated corporate bonds pub-
licly issued in the U.S. bond market.10 Qualifying securities must have at least one
year remaining term-to-maturity, a fixed coupon schedule, and a minimum amount
outstanding of $100 million for below investment-grade and $150 million for investment-
grade issuers.
To calculate an overall credit spread on the firm’s outstanding bonds, we matched
the daily effective yield on each individual security issued by the firm to the esti-
mated yield on the Treasury coupon security of the same maturity. Treasury yields
8The membership in our panel is limited to firms that reported at least 4 consecutive quarters of
income and balance sheet data.
9We restrict the numerator of the leverage ratio to long-term debt because our secondary-market
prices pertain to long-term corporate securities. In addition, firms often maintain a stock of liquid
assets to cover their short-term liabilities.
10The Merrill Lynch individual security prices are available starting in 1997.
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