The Effect of Credit Rating Downgrades and Customer-supplier Relationships

Abstract

Extant research documents the valuation effects of credit rating change on the stock price. This study extends the research by examining the information transfer effects of customer credit rating downgrades on supplier firms. We find that supplier firms experience negative abnormal returns during the announcement of customer firms’ rating downgrades. This effect persists over a 50 trading day window after the downgrade announcement. We also find that credit rating deterioration spreads along the supply chain, where the probability of future rating downgrades is significantly higher for supplier firms with downgraded customers. Further, we show that the information transfer effects are associated with certain cross-sectional factors, including the market anticipation of customers rating downgrades, the strength of the customer-supplier linkage, the valuation effects within customer firms’ industries, and investor attention on supplier firms.

Keywords: Credit rating downgrade; customer-supplier economic linkage; cumulative abnormal returns (CARs); credit risk

JEL Classification: G12; G14; G24