Working Papers

Corporate Debt Complexity and Equity Behavior

I examine how the complexity of firm debt affects the incorporation of news into equity prices. As residual claimants to firm cash flows, equity investors must accurately value all outstanding debt contracts, suggesting that complex debt can interfere with their ability to process news effectively. Using a model where a subset of investors initially underestimate the precision of news, I derive three predictions for the equity behavior of firms with complex debt: (1) they exhibit greater post-announcement drift, (2) they show elevated trading volume both on announcement day and in the post-announcement period, and (3) their return volatility decreases on announcement day but increases during the post-announcement period. These predictions are strongly supported by empirical evidence in the context of earnings announcements. These findings suggest that debt complexity creates meaningful frictions in how fundamental news is incorporated into equity markets.