I have started to think recently quite a bit about firm’s own credit risk and I think it is an area research has the potential to be helpful to standard setting. Barth Hodder and Stubben (TAR 2008) investigate the association between equity returns and credit risk changes. Consistent with Merton (1974), the relation between credit risk changes and equity returns is significantly less negative for firms with more debt. I think this is a very interesting paper and great introduction for people thinking about the fair value of financial liabilities. However, I still think there is lots of interesting questions to ponder. For example, how do we measure own credit risk? Should we separate changes in own credit risk related to general economic conditions from firm specific changes? What disclosures should you make about own credit risk?
Own credit risk is a critical component of the fair value of a liability and one we really do not understand in much detail. I think this is a concept that is ripe for more research.