Model Specification

I use the length of earnings string (ES_String) and MBE string (MBE_String) for the proxies of the earnings benchmark string. To test H1, I use the following regression model to examine the association between the bond yield spread and the length of the earnings benchmark string:

Spreadiq = α0 + α1ES_Stringiq /MBE_Stringiq + α2Sizeiq + α3Lossiq + α4StdRetiq + α5Tobin’s Qiq

+ α6Leviq + α7CFOiq + α8Liqiq+ α9Tangiq + α10ROAiq + α11IssueSizeiq + (α12Dacci + α13Ab_Dexpiq + α14Ab_Prodiq) + ∑αtYeariq + ∑αtIndustryiq + εiq (1)

Where:

Spread = the yield to maturity at the issuance date for the largest bond firm it issued in

year t minus the Treasury bond yield with similar maturity. I also measure spread

as the natural logarithm of the initial bond spread.

ES_String = the natural logarithm of the length of the earnings string measured by a sequence of quarters in which a firm’s EBIT is higher than that of the same fiscal quarter from the previous year.

MBE_String = the natural logarithm of the length of the MBE string measured by a sequence of quarters in which a firm’s actual earnings meet or beat analysts’ most recent consensus forecasts before the earnings quarterly announcement date.

Size = the natural logarithm of firm i’s total assets at the end of quarter q.

Loss =equal to one if there is a loss in the current fiscal year, and zero otherwise.

StdRet = the standard deviation of firm i’s daily stock returns during quarter q.

Tobin’s Q =firm i’s market value of assets/the book value of assets at the end of quarter q.

Lev =firm i’s total debt/total assets at the end of quarter q.

CFO =firm i’s operating cash flow/total assets at the end of quarter q.

Liq = the ratio of new liquid assets (total current assets – total current liabilities) to total assets at the end of quarter q.

Tang =the ratio of net property, plant, and equipment over total assets at the end of quarter q.

ROA =firm i’s return on assets at the end of year t measured by income before extraordinary items scaled by average total assets (quarter q-1 and 1).

IssueSize =the natural logarithm of the offering amount of the bond (in millions of dollars).

Dacc = firm i’s quarterly discretionary accruals measured by a modified Dechow and

Dichev (2002) cash flow accrual model.3

3 _{The Dechow and Dichev (2002) cash flow accrual model regresses working capital accruals on operating cash flows} in the prior, current, and future periods. The Dechow and Dichev (2002) model improved the traditional Jones model by explicitly mapping cash flows into the accruals generating process, which, I believe, is particularly important in the debt market. Further, as suggested by McNichols (2002), I also include the change in sales revenue and a fourth quarter indicator variable into the model in order to increase explanatory power. Specifically, I estimate discretionary accruals by regressing the following model for each industry group: ∆WCt=b0 + b1CFOt-1 + b2CFOt + b3CFOt+1

Ab_Dexp = firms i’s quarterly abnormal expenditures measured by Roychowdhury’s (2006)

real earnings management model.

Ab_Prod = firms i’s quarterly abnormal production measured by Roychowdhury’s (2006)

real earnings management model.

If debt holders view firms that sustain a string of earnings benchmarks as risky borrowers, then I expect that the coefficient on ES_Stringiq/MBE_Stringiq will be significantly positive,

suggesting that debt holders demand a higher risk premiums from firms that sustain a string of earnings benchmarks. To test H2, I use the following regression model to examine the association between the credit rating and the length of the earnings benchmark string:

SP_Ratingiq = α0 + α1ES_Stringiq /MBE_Stringiq + α2Sizeiq + α3Lossiq+ α3StdRetiq + α4Tobin’s Qiq

+ α5Leviq + α6CFOiq + α7Liqiq+ α8Tangiq + α9ROAiq + α10IssueSizeiq + (α11Dacciq

+ α12Ab_Dexpiq+ α13Ab_Prodiq) + ∑αtYeariq + ∑αtIndustryiq + εiq (3)

Where: SP_Ratingiq is the firm’s S&P ratings from AAA (indicating a string capacity to

pay interest and repay principal) to D (indicating actual default). I transform S&P ratings into a 22-point scale with a smaller number indicating a better rating. Table 1 provides a detailed rating-

scale index. Consistent with Jiang (2008), the BBB rating-scale has the largest observations.4 If

credit rating agencies also view firms that sustain a string of earnings benchmarks as risky borrowers, then I expect the coefficient on ES_/MBE_Stringiq will be significantly positive.

Further, to examine whether the debt market reacts differently from the equity market to firms that sustain a string of earnings benchmarks, I also use the following regression model to

examine the association between firms’ abnormal stock returns and the length of the earnings benchmark string:

CAR (-1, 1)iq/ BHAR (-1, 1)iq = α0 + α1ES_Stringiq /MBE_Stringiq + α2Sizeiq + α3Lossiq

+ α4Tobin’s Qiq+ α5Leviq + α6CFOiq + α7Liqiq+ α8Tangiq + α9ROAi + α10IssueSizeiq + (α11Dacciq + α12Ab_Dexpiq + α13Ab_Prodiq)

+ ∑αtYeariq + ∑αtIndustryiq + εiq (4)

Where: CAR (-1, 1)iq is firm i’s cumulative abnormal returns measured over three days (-

1, +1) around the quarterly earnings announcement date. The abnormal returns are obtained from a Carhart (1997) four-factor model with the CRSP value-weighted index return as the market returns.5 The parameters of the model are estimated over the period day -300 to day -60. In addition, I also use buy-and-hold abnormal returns (BHAR) as an alternative proxy as it can effectively avoid a rebalancing bias in the monthly reference index returns (Lyon, Barber, and Tsai, 1999).

BHAR (-1, 1)iqis firm i’s buy-and-hold abnormal returns measured over three days (-1, +1) around

the quarterly earnings announcement date. The abnormal returns are also obtained from a Carhart (1997) four-factor model with the CRSP value-weighted index return as the market return. If the equity market rewards firms that sustain a string of earnings benchmarks, then I expect the coefficient on ES_Stringiq/MBE_Stringiq will be significantly positive.

5 _{The Carhart (1997) four-factor model extend Fama-French (1989) three-factor model by including a momentum} factor. The momentum is estimated by subtracting the equally-weighted average of the lowest performing firms from the equally-weighted average of the highest performing firm, lagged one month.