The Long-Run Stock Returns Following Bond Ratings Changes

43 Pages Posted: 13 Nov 1998

See all articles by Ilia D. Dichev

Ilia D. Dichev

Emory University - Department of Accounting

Joseph D. Piotroski

Stanford Graduate School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: October 1998


We use a comprehensive sample that comprises essentially all Moody's bond rating changes between 1970 and 1997 to examine the long-run stock returns following the changes. Our main finding is that stocks with upgrades outperform stocks with downgrades for up to one year following the announcement but we find little or no reliable difference in returns thereafter. The return differential between stocks with upgrades and downgrades is on the magnitude of 10 to 14 percent in the year following the announcement, and is mostly due to the poor performance of stocks with downgrades. Additional tests reveal that the underperformance of downgrades is primarily due to the poor returns of small and low credit quality firms, which are likely the firms with the largest information problems. Probing into the causes for this phenomenon, we find that current ratings changes predict changes in future ratings and future profitability. More importantly, we find some evidence of significant differences in returns at subsequent earnings announcements of stocks with upgrades and downgrades, which suggests that the market does not fully anticipate the predictable future changes in earnings. We also find strong evidence that the magnitude of the post-announcement returns is increasing in the magnitude of the pre-announcement returns, consistent with a delayed and gradual adjustment to the announcement information. Thus, the limited duration of abnormal returns, the pattern of predictable reactions at subsequent earnings announcements, and the strong relation between pre and post-announcement returns suggest that the abnormal post-announcement returns are at least partly due to incomplete adjustment to information.

JEL Classification: G12, G14

Suggested Citation

Dichev, Ilia D. and Piotroski, Joseph D., The Long-Run Stock Returns Following Bond Ratings Changes (October 1998). Available at SSRN: or

Ilia D. Dichev (Contact Author)

Emory University - Department of Accounting ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

Joseph D. Piotroski

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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