Information Transfer Effects of Bond Rating Downgrades

This paper investigates information transfer effects of bond rating downgrades measured by equity abnormal returns for industry portfolios. Industry rivals can be subject to two opposing effects, the contagion effect and the competition effect. We find that the net effect is strongly dependent on the original bond rating of the downgraded firm. For investment‐grade (speculative‐grade) firms, industry abnormal equity returns are negative (positive), which implies a predominant contagion (competition) effect. The analysis reveals a rich pattern of positive and negative correlations across negative credit events, which can be used to improve our understanding of portfolio credit risk models.     

Does sovereign debt ratings news spill over to international stock markets?

The evidence here indicates that sovereign debt rating and credit outlook changes of one country have an asymmetric and economically significant effect on the stock market returns of other countries over 1989–2003. There is a negative reaction of 51 basis points (two-day return spread vis-á-vis the US) to a credit ratings downgrade of one notch in a common information spillover around the world. Upgrades, however, have no significant impact on return spreads of countries abroad. Closeness (e.g., geographic proximity) and emerging market status amplify the effect of a spillover. Downgrade spillover effects at the industry level are more pronounced in traded goods and small industries.     

Industry Structure and Corporate Debt Maturity

We examine how industry competition affects firms’ choice of short‐term debt. We find that the percentage of short‐term debt is positively related to industry concentration at low levels of concentration, and inversely related to industry concentration at higher levels of concentration. This nonlinear relation is stronger in industries where firms are either more homogeneous or compete more aggressively. Moreover, we find that firms with shorter‐maturity debt are less aggressive than their rivals in the product market. The overall evidence suggests that although financial contracts alleviate agency problems, they exacerbate the risk of predation.     

The impact of bond rating changes on corporate bond prices: New evidence from the over-the-counter market

I study the information content of bond ratings changes using daily corporate bond data from TRACE. Abnormal bond returns over a two-day event window that includes the downgrade (upgrade) are negative (positive) and statistically significant, although the reaction to upgrades is economically small. Monthly abnormal bond returns around downgrades and upgrades are statistically significant but overstate the magnitude of the reaction relative to two-day abnormal returns. Unlike the bond market, the stock market reaction to upgrades is statistically insignificant. Evidence suggests that the differing inferences on the effect of upgrades in the two markets can be attributed to wealth transfer effects rather than relative market inefficiencies. In the cross-section, the bond market response is stronger for rating changes that appear more surprising, rating changes of lower rated firms, and upgrades that move the firm from speculative grade to investment grade.     

The information content of issuer rating changes: Evidence for the G7 stock markets

We study the firm-specific and intra-industry stock market effects of issuer credit rating changes and negative watch list placements for the G7 countries. We show that both the information content and the information transfer effects of these rating signals differ considerably in terms of magnitude and in terms of direction across the G7 countries. In particular, conditional on the type of rating change we find significant contagion effects for the US, the UK and Italy, but not for the other G7 countries. Moreover, we show that in some countries abnormal industry portfolio returns associated with rating downgrades and negative watch list signals tend to be more negative for more concentrated and more heavily levered industries. Overall, our results shed new light on country-specific differences in the relevance of credit ratings as risk indicators from an equity investor's perspective, and they may also be of interest to both risk managers and financial market supervisors striving to develop more accurate credit risk models and to better assess the systemic relevance of credit ratings.     

INDUSTRY EFFECTS OF ANALYST STOCK REVISIONS

We examine the industry valuation effects of analyst stock revisions and identify the variables that influence these effects. Our results show that industry rivals experience significant abnormal returns in response to revision announcements. Although the mean stock price response suggests contagion effects, there is also evidence of significant competitive effects. The valuation effects are influenced by the magnitude of the rated firm's announcement return, along with analyst‐specific and industry‐specific characteristics. However, the sensitivity of the valuation effects to these characteristics is conditioned on whether the industry effects are contagious or competitive.     

Financial Reporting and Credit Ratings: On the Effects of Competition in the Rating Industry and Rating Agencies' Gatekeeper Role

This paper studies firms' financial reporting incentives in the presence of strategic credit rating agencies and how these incentives are affected by the level of competition in the rating industry and by rating agencies' role as gatekeepers to debt markets. We develop a model featuring an entrepreneur who seeks project financing from a perfectly competitive debt market. After publicly disclosing a financial report, the entrepreneur can purchase credit ratings from rating agencies that strategically choose their rating fees and rating inflation. We derive the following core results: (1) More rating industry competition leads to stronger corporate misreporting incentives if ratings are sufficiently precise or if rating agencies assume a gatekeeper role. Under imperfect rating industry competition, (2) agencies' gatekeeper role primarily weakens firms' misreporting incentives, which then influences rating agencies' strategies, and (3) firms' misreporting and rating agencies' rating inflation can be strategic complements when agencies assume a gatekeeper role. (4) Regulatory initiatives aimed at increasing rating industry competition or at weakening rating agencies' gatekeeper role improve investment efficiency as long as corporate misreporting incentives are not significantly strengthened.     

Sovereign Credit Risk,Banks' Government Support,and Bank Stock Returns around the World

We explore the joint effect of expected government support to banks and changes in sovereign credit ratings on bank stock returns using data for banks in 37 countries between 1995 and 2011. We find that sovereign credit rating downgrades have a large negative effect on bank stock returns for those banks that are expected to receive stronger support from their governments. This result is stronger for banks in advanced economies where governments are better positioned to provide that support. Our results suggest that stock market investors perceive sovereigns and domestic banks as markedly interconnected, partly through government guarantees.     

Arbitrage-free credit pricing using default probabilities and risk sensitivities

The relation between physical probabilities (rating) and risk-neutral probabilities (pricing) is derived in a large market with a quasi-factor structure. Factor sensitivities and default probabilities are obtainable for all kinds of credits on historical rating data. Since factor prices can be backed out from market data, the model allows the pricing of non-marketable credits and structured products thereof. The model explains various empirical observations: credit spreads of equally rated borrowers differ, spreads are wider than implied by expected losses, and expected returns on CDOs must be greater than their rating matched, single-obligor securities due to the inherent systematic risk.     

Competition and the cost of debt

This paper empirically shows that the cost of bank debt is systematically higher for firms that operate in competitive product markets. Using various proxies for product market competition, and reductions of import tariff rates to capture exogenous changes to a firm's competitive environment, I find that competition has a significantly positive effect on the cost of bank debt. Moreover, the analysis reveals that the effect of competition is greater in industries in which small firms face financially strong rivals, in industries with intense strategic interactions between firms, and in illiquid industries. Overall, these findings suggest that banks price financial contracts by taking into account the risk that arises from product market competition.     

The debt market relevance of management earnings forecasts: evidence from before and during the credit crisis

We investigate the credit market’s response via changes in credit default swap (CDS) spreads to management earnings forecasts and evaluate the importance of these forecasts relative to earnings news during the periods before and during the recent credit crisis. We document that credit markets react significantly to management forecast news and that the reactions to forecast news are stronger than to actual earnings news. Consistent with the asymmetric payoffs to debt holders, the forecast news is mainly relevant for firms with poor credit rating or announcing bad news. We also show that the relevance of management forecasts to credit markets is particularly strong during periods of high uncertainty, as experienced during the recent credit crisis.     

Credit default swap spreads and variance risk premia

We find that the firm-level variance risk premium has a prominent explanatory power for credit spreads in the presence of market- and firm-level control variables established in the existing literature. Such predictability complements that of the leading state variable—the leverage ratio—and strengthens significantly with a lower firm credit rating, longer credit contract maturity, and model-free implied variance. We provide further evidence that (1) the variance risk premium has a cleaner systematic component than implied variance or expected variance, (2) the cross-section of firms’ variance risk premia capture systematic variance risk in a stronger way than firms’ equity returns in capturing market return risk, and (3) a structural model with stochastic volatility can reproduce the predictability pattern of variance risk premia for credit spreads.     

Dispersion in analysts’ earnings forecasts and credit rating

This paper shows that the puzzling negative cross-sectional relation between dispersion in analysts’ earnings forecasts and future stock returns may be explained by financial distress, as proxied by credit rating downgrades. Focusing on a sample of firms rated by Standard & Poor's (S&P), we show that the profitability of dispersion-based trading strategies concentrates in a small number of the worst-rated firms and is significant only during periods of deteriorating credit conditions. In such periods, the negative dispersion–return relation emerges as low-rated firms experience substantial price drop along with considerable increase in forecast dispersion. Moreover, even for this small universe of worst-rated firms, the dispersion–return relation is non-existent when either the dispersion measure or return is adjusted by credit risk. The results are robust to previously proposed explanations for the dispersion effect such as short-sale constraints and leverage.     

债券评级机构变更——基于评级选购与评级迎合视角

本文以2008年至2017年的公司债券为样本,研究了发行人变更评级机构的影响,以此来解释评级市场上发行人频繁变更评级机构的现象。本文发现发行人变更评级机构后,其信用等级得到显著提升。发行人变更评级机构的行为对信用等级的影响在以下两种情形中更显著:一是当发行人所处行业或评级机构所在的评级市场竞争激烈时;二是当发行人主体评级位于AA信用等级的临界点时。进一步研究发现,考虑到评级机构变更与信用等级之间的交互影响,变更评级机构的发行人整体上可实现发债成本的降低。但该类发行人未来的违约风险增加、经营业绩下降。最后,本文发现债券发行规模较大以及非国有发行人更倾向于变更评级机构来提高信用等级。本文通过分析发行人更换信用评级机构的动机和后果,为监管部门构建以评级质量为导向的良性竞争环境提供借鉴参考。     

Did Subjectivity Play a Role in CDO Credit Ratings?

Analyzing 916 collateralized debt obligations (CDOs), we find that a top credit rating agency frequently made positive adjustments beyond its main model that amounted to increasingly larger AAA tranche sizes. These adjustments are difficult to explain by likely determinants, but exhibit a clear pattern: CDOs with smaller model‐implied AAA sizes receive larger adjustments. CDOs with larger adjustments experience more severe subsequent downgrading. Additionally, prior to April 2007, 91.2% of AAA‐rated CDOs only comply with the credit rating agency's own AA default rate standard. Accounting for adjustments and the criterion deviation indicates that on average AAA tranches were structured to BBB support levels.     

ESG in credit ratings and the impact on financial markets

This study examines environment, social, governance (ESG) consideration in rating reports published by credit rating agencies. 3,719 Moody's credit rating reports between 2004 and 2015 are examined and the ESG consideration is analyzed using a latent dirichlet allocation (LDA) approach. We further analyze the stock returns and credit default swap (CDS) spread changes to check whether ESG consideration has an effect on the capital market reactions. We find a small but present consideration of ESG in rating decisions. Within ESG, corporate governance plays the most important role. Moreover, the results reveal that ESG consideration is a significant determinant in the stock return and CDS spread around the rating announcement. We find that all ESG criteria are important for equity and debt investors.     

Are All Rivals Affected Equally by Bond Rating Downgrades?

We use revisions in analysts' earnings forecasts to examine how the bad news associated with a bond rating downgrade gets transferred from the downgraded company to its rivals. In general, we find that stock analysts revise their earnings expectations downward for rivals of companies with downgraded debt. However, the significance of the revision is limited to rivals of downgraded companies with non-investment grade debt only. For the rivals of companies with investment grade debt, we find no significant forecast revisions. We hypothesize that this differential impact is due to differing levels of market visibility. This is consistent with our finding that downgraded companies with non-investment grade debt are followed by significantly fewer stock analysts. Apparently not all rivals are affected equally by bond rating downgrades.     

The effects of bank relationships on firm private debt restructuring: Evidence from an emerging market

Our paper seeks to examine the direct benefit of bank relationships for a distressed borrower by assessing its influence on the success of firm private debt restructuring. We find that a distressed firm with a stronger bank relationship has a greater probability to successfully restructure its debt through private renegotiation. Accordingly, an analysis of credit rating recovery provides complementary evidence on the factors of successful debt restructuring. A duration analysis of the length of time needed for a debt restructuring to be completed is fully consistent with our documented results. We conclude that in a bank dominated financial system like Taiwan's where firms are heavily bank-dependent, the bank-firm relationship is of crucial importance to the success of financially distressed firms in private debt restructuring.     

Lead–Lag Effects in Australian Industry Portfolios

This study finds that returns to stocks with relatively high market capitalizations lead returns to stocks with relatively low market capitalizations in Australian industry portfolios. These lead–lag patterns or positive cross-correlations are found in both daily and weekly returns and continue to hold even after the market factor is removed. The results for weekly returns are consistent with the findings of Hou (Rev Fin Stud 20:1113–1138, 2007) who found significant lead–lag effects in weekly returns to US industry portfolios. However while that study found stronger lead–lag effects for industries with relatively small average market capitalizations this study finds that industries with larger average market capitalizations have stronger lead–lag effects. This may be caused by industry momentum created by positive news to the leader stocks of an industry, and implies investors can gain significantly by investing in the smaller firms of prominent industries, following an earlier shock to the corresponding leader stocks.     

Financial statement comparability and credit risk

Prior research shows that firms’ financial statement comparability improves the accuracy of market participants’ valuation judgments and thus may reduce firms’ costs of capital. Distinct from prior research focusing on the equity market, we develop measures of comparability relevant to debt market participants based on the within-industry variability of Moody’s adjustments to reported accounting numbers for the purposes of credit rating. We examine two sets of adjustments: (1) to the interest coverage ratio and (2) to non-recurring income items. We validate these comparability measures by providing evidence that greater comparability is associated with lower frequency and magnitude of split ratings by credit rating agencies. We predict and find that greater comparability is associated with (1) lower estimated bid-ask spreads for traded bonds, (2) lower credit spreads for both bonds and five-year credit default swaps, and (3) a steeper one- to five-year credit default swap term structure. Our results are consistent with financial statement comparability reducing debt market participants’ uncertainty about and pricing of firms’ credit risk.