Does Other Comprehensive Income Volatility Influence Credit Risk and the Cost of Debt?*
MAY XIAOYAN BAO, University of New Hampshire
MATTHEW T. BILLETT, Indiana University
DAVID B. SMITH, University of Nebraska†
EMRE UNLU, University of Nebraska
CAR

ABSTRACT
We examine the usefulness of other comprehensive income (OCI) to debt investors in
nonfinancial companies. Motivated by Merton’s (1974) real options framework, we construct a
measure of incremental OCI volatility, designed to capture the effect of OCI on overall firm
asset volatility, which is a primary driver of credit risk in Merton’s (1974) model. We find that
the volatility of incremental OCI influences the likelihood of default, credit ratings, and the cost
of debt. Overall, our evidence suggests that creditors use information from OCI in their
assessment of firm credit risk and in pricing debt contracts.