Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing

Abstract

Rating agencies have become more conservative in assigning corporate credit ratings over the period 1985 to 2009; holding firm characteristics constant, average ratings have dropped by three notches. This change does not appear to be fully warranted because defaults have declined over this period. Firms affected more by conservatism issue less debt, have lower leverage, hold more cash, are less likely to obtain a debt rating, and experience lower growth. Their debt spreads are lower than those of unaffected firms with the same rating, which implies that the market partly undoes the impact of conservatism on debt prices. This evidence suggests that firms and capital markets do not perceive the increase in conservatism to be fully warranted.

Does mandatory IFRS adoption facilitate debt financing?

“…This comports with prior studies that also report different dynamics for voluntary adopters at the time of the IFRS mandate (e.g., Li 2010). 21 Results on control variables are again consistent with prior studies (Bharath et al 2008;Kim et al 2011;Baghai et al 2014).…”

“…These include firm-specific variables that capture observable characteristics of firms' default risk: Size, Tangibility, Leverage, Market to Book, O-Score, Investment Grade, Rated, Current Ratio, ROA, Returns, and Return Variability (Bharath et al 2008;Ball et al 2013;Baghai et al 2014). We also control for issue-specific characteristics that are systematically related to debt pricing.…”

“…Finally, we include two country factors that may be associated with the cost of debt, namely, Term Spread as a proxy for economic uncertainty (Campbell and Taksler 2003;Graham et al 2008) and Median Distance to Default (DTD) as an overall country-level measure of corporate default risk (Correia et al 2012;Baghai et al 2014). 10 In all models under Eqs.…”

Multivariate ordinal regression models: an analysis of corporate credit ratings

“…We assume that errors are independent across firms and years with distribution function F ht,q ht and orthogonal to the covariates. The year intercepts should capture stringency or loosening of the rating standards of each CRA relative to a baseline year, in our case the first year in the sample (like in Blume et al 1998;Alp 2013;Baghai et al 2014). In order to simplify notation, the n × (T − 1) matrix of year dummies D will be incorporated together with the covariates into a new matrix X = (D X) and the vector β j = (α j , β j ) will contain the T − 1 year intercepts α j and the vector of slope coefficients β j .…”

The Real Effects of Credit Ratings: The Sovereign Ceiling Channel

“…Second, we contribute to the literature on the effects of credit ratings on firm outcomes. This literature shows that credit ratings matter for capital structure decisions (Kisgen (2006)) and cost of capital (Kisgen and Strahan (2010), Baghai, Servaes, and Tamayo (2014)), as well as for firms' real decisions (Sufi (2009), Tang (2009, Lemmon and Roberts (2010), Chernenko and Sunderam (2012), and Harford and Uysal (2014)). 7 However, these studies are subject to omitted variables concerns because changes in ratings are correlated with changes in firm fundamentals.…”