Chasing Forecasts: The Relative Timing of Equity and Debt Ratings

Abstract

Both bond rating agencies and equity analysts evaluate publicly traded companies, offering their opinions as a service to investors. Yet, as the recent financial crisis has clearly shown, the quality and timeliness of rating agencies information is questionable. In this paper, we show that equity forecasts significantly anticipate rating actions. On a large, cross-country dataset of 2,286 rating actions and 75,689 target prices issued on Us and European listed companies, we show that when prior changes in the average equity price target are in excess of 20%, the probability of observing a rating action ranges from 80 to 100%. This anticipation effect is stronger for financial companies and is homogeneous across rating agencies. Additionally, we show that rating actions and watchlist are partially substitutes as equity price forecasts anticipation effect is almost identical to that of uncontaminated rating actions. Our results survive the financial-crisis test as albeit weakened, equity forecasts still significantly anticipate downgrades by rating agencies, suggesting a resilience of the agencies in delaying revisions.

Keywords: Ratings, Target Prices, Market efficiency

JEL Classification: G18, G28, G32