The Informational Content of Bond Ratings

Abstract

This paper explores the risk structure of interest rates. The focus is on whether yields on industrial bonds indicate that market participants base their evaluations of a bond issue's default risk on agency ratings or on publicly available financial statistics. Using a non-linear least squares procedure, the yield-to-maturity is related to Moody's rating, Standard and Poor's (S&P) rating, and accounting measures of creditworthiness such as coverage and leverage. Market yields are found to be significantly correlated with both the ratings and a set of readily available financial accounting statistics. These results indicate (1) that market participants base their evaluations of an issue's creditworthiness on more than the agencies' ratings and (2) that the ratings bring some information to the market above and beyond that contained in the set of accounting variables. The paper also asks whether the market views Moody's and Standard and Poor's ratings as equally reliable measures of risk or whether the market attaches more weight to one agency's ratings than the other. Finally, the hypothesis that the market pays more attention to the accounting measures and less to the ratings if the rating has not been reviewed recently is tested.

Credit Ratings as Coordination Mechanisms

“…11 For example, Brealey and Myers (2000) claim that "Firms and governments, having noticed the link between bond ratings and yields, worry that a reduction in rating will result in higher interest charges. They almost certainly exaggerate the influence of the ratings agencies, who are as much following investor opinion as leading it."…”

Rating Alignment, Rating Shopping and Reputation of Credit Rating Agencies: Evidence from the Subprime Crisis

“…Market trust in CRA evaluations has driven coupon spreads and debt value to be strongly influenced by ratings (see, for example, Ederington et al, 1987 andKliger andSarig, 2000). Moreover, many financial regulatory institutions have used their ratings as official benchmarks for the credit risk of bonds and structured obligations in defining restrictions on investors' behavior.…”

Determinants and Impacts of Internal Credit Rating

“…Financial statements and other statements are no longer enough to meet the needs of all users, and so a CRA will supply a report providing valid and pertinent additional information on the organization (Sherwood, 1976;Belkaoui, 1983;Ederington et al, 1987;Pottier, 1998;Pottier and Sommer, 1999). Therefore, it can be said that credit rating will help in improving the efficiency of financial statements in specific and accounting in general terms.…”

“…The first goal of a firm's financing strategy is to achieve the desired rating from one of NRSROs, indicating financial soundness, efficiency of internal control systems and more general managerial competence, providing a good signal to the external environment (e. g. investors) through the level of CR (Cantor, 1994;Gonzalez, 2004). A number of researchers have illustrated the importance of CR in finance (for example, Sherwood, 1976;Kaplan and Urwitz, 1979;Belkaoui, 1983;Ederington et al, 1987;Pottier, 1998;Pottier and Sommer, 1999;Gabbi and Sironi, 2002;Gonzalez, 2004).…”