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Anatomy of a ratings change

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  • Marble III, Hugh
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    Abstract

    I document the frequency with which credit rating changes result from changes in the firm's operating environment versus changes in capital structure controlled by management. I find that management action plays a significant role in credit rating changes. Twenty-eight percent of downgrades and 44% of upgrades have a substantial management influence. The frequency of management impact on credit ratings shows the limitations of credit risk modeling using structural models that assume constant capital structure. Even the cases in which firms are downgraded across the investment/speculative grade threshold can be driven by management actions rather than operating or economic conditions. Twenty-two percent of the observations of firms newly downgraded to speculative grade are entirely attributable to management action. The frequency of management-driven changes exhibits yearly and industry variation.

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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 51 (2011)
    Issue (Month): 1 (February)
    Pages: 105-112

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    Handle: RePEc:eee:quaeco:v:51:y:2011:i:1:p:105-112

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    Web page: http://www.elsevier.com/locate/inca/620167

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    Keywords: Credit ratings Financial policy;

    References

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    1. Darren J. Kisgen, 2007. "The Influence of Credit Ratings on Corporate Capital Structure Decisions," Journal of Applied Corporate Finance, Morgan Stanley, vol. 19(3), pages 65-73.
    2. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    4. Acharya, Viral V & Carpenter, Jennifer, 2002. "Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy," CEPR Discussion Papers 3328, C.E.P.R. Discussion Papers.
    5. Hendrik Bessembinder & Kathleen M. Kahle & William F. Maxwell & Danielle Xu, 2009. "Measuring Abnormal Bond Performance," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4219-4258, October.
    6. Pierre Collin-Dufresne, 2001. "Do Credit Spreads Reflect Stationary Leverage Ratios?," Journal of Finance, American Finance Association, vol. 56(5), pages 1929-1957, October.
    7. Sanjeev Bhojraj & Partha Sengupta, 2003. "Effect of Corporate Governance on Bond Ratings and Yields: The Role of Institutional Investors and Outside Directors," The Journal of Business, University of Chicago Press, vol. 76(3), pages 455-476, July.
    8. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. " The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-52, June.
    9. Klock, Mark S. & Mansi, Sattar A. & Maxwell, William F., 2005. "Does Corporate Governance Matter to Bondholders?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(04), pages 693-719, December.
    10. Goh, Jeremy C & Ederington, Louis H, 1993. " Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?," Journal of Finance, American Finance Association, vol. 48(5), pages 2001-08, December.
    11. Darren J. Kisgen, 2006. "Credit Ratings and Capital Structure," Journal of Finance, American Finance Association, vol. 61(3), pages 1035-1072, 06.
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