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Do Regulations Based on Credit Ratings Affect a Firm's Cost of Capital?

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  • Darren J. Kisgen
  • Philip E. Strahan
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    Abstract

    In February 2003, the SEC officially certified a fourth credit rating agency, Dominion Bond Rating Service ("DBRS"), for use in bond investment regulations. After DBRS certification, bond yields change in the direction implied by the firm's DBRS rating relative to its ratings from other certified rating agencies. A one notch better DBRS rating corresponds to a 39 basis point reduction in a firm's debt cost of capital. The impact on yields is driven by cases where the DBRS rating is better than other ratings and is larger among bonds rated near the investment-grade cutoff. These findings indicate that ratings-based regulations on bond investment affect a firm's cost of debt capital.

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    File URL: http://www.nber.org/papers/w14890.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14890.

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    Date of creation: Apr 2009
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    Handle: RePEc:nbr:nberwo:14890

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    1. Kisgen, Darren J., 2009. "Do Firms Target Credit Ratings or Leverage Levels?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(06), pages 1323-1344, December.
    2. 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.
    3. Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September.
    4. Doron Kliger & Oded Sarig, 2000. "The Information Value of Bond Ratings," Journal of Finance, American Finance Association, vol. 55(6), pages 2879-2902, December.
    5. Dion Bongaerts & K. J. Martijn Cremers & William N. Goetzmann, 2012. "Tiebreaker: Certification and Multiple Credit Ratings," Journal of Finance, American Finance Association, vol. 67(1), pages 113-152, 02.
    6. 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.
    7. Darren J. Kisgen, 2006. "Credit Ratings and Capital Structure," Journal of Finance, American Finance Association, vol. 61(3), pages 1035-1072, 06.
    8. Richard Cantor & Frank Packer & Kevin Cole, 1997. "Split ratings and the pricing of credit risk," Research Paper 9711, Federal Reserve Bank of New York.
    9. Ederington, Louis H. & Goh, Jeremy C., 1998. "Bond Rating Agencies and Stock Analysts: Who Knows What When?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(04), pages 569-585, December.
    10. West, Richard R, 1973. "Bond Ratings, Bond Yields and Financial Regulation: Some Findings," Journal of Law and Economics, University of Chicago Press, vol. 16(1), pages 159-68, April.
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    Cited by:
    1. Doherty, Neil A. & Kartasheva, Anastasia V. & Phillips, Richard D., 2012. "Information effect of entry into credit ratings market: The case of insurers' ratings," Journal of Financial Economics, Elsevier, vol. 106(2), pages 308-330.

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