Characteristics and Information Value of Credit Watches

Abstract

We analyze credit watch and rating actions to better understand the role of credit watches in the credit rating process. We find that watch actions are more frequently prompted by specific, publicly known events than are rating actions. The likelihood that a watch action precedes a rating action varies systematically with proxies for investor demand for credit quality information and the adverse consequences of issuing a rating change prematurely. Credit watches occur more often in response to deterioration in credit quality, and issuers make concerted efforts to address the concerns that prompted down watches. Down watches are less likely than up watches to indicate the direction of the subsequent rating change. Watch announcements are associated with abnormal stock returns, indicating that credit watch actions are significant information events. Overall, our results support the hypothesis that credit watches enhance both the information-supplying role of credit rating agencies and the use of credit ratings in contracting.

Keywords: Credit watches, Credit rating agencies (CRAs), Bond ratings, Market impact, Contracting, Information supply

JEL Classification: G14, G24, G33