Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing

Journal of Finance, Forthcoming

63 Pages Posted: 12 Jun 2011 Last revised: 22 Jul 2013

Ramin Baghai

Stockholm School of Economics

Henri Servaes

London Business School; Centre for Economic Policy Research (CEPR)

Ane Tamayo

London School of Economics & Political Science (LSE)

Multiple version iconThere are 2 versions of this paper

Date Written: July 22, 2013

Abstract

We show that rating agencies have become more conservative in assigning credit ratings to corporations over the period 1985 to 2009. Holding firm characteristics constant, average ratings have dropped by three notches (e.g., from A to BBB ) over time. Consistent with the view that this change has not been fully warranted, we find that defaults for both investment grade and non-investment grade firms have declined over time. The increased stringency has also affected capital structure, cash holdings, growth, and debt spreads. Firms that suffer more from this conservatism issue less debt, have lower leverage, and hold more cash; they are also less likely to obtain a debt rating and they experience lower sales growth. However, their debt spreads are lower compared to the spreads of firms with the same rating that have not suffered from this conservatism, which implies that the market partly undoes the impact of conservatism on debt prices. This evidence suggests that firms and capital markets do not perceive the increase in conservatism to be fully warranted.

Keywords: credit ratings, capital structure, debt issues, debt spreads

JEL Classification: G32

Suggested Citation

Baghai, Ramin and Servaes, Henri and Tamayo, Ane, Have Rating Agencies Become More Conservative? Implications for Capital Structure and Debt Pricing (July 22, 2013). Journal of Finance, Forthcoming . Available at SSRN: https://ssrn.com/abstract=1860998 or http://dx.doi.org/10.2139/ssrn.1860998

Ramin Baghai

Stockholm School of Economics ( email )

PO Box 6501
Stockholm, 11383
Sweden

Henri Servaes (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7000 8268 (Phone)
+44 20 7000 8201 (Fax)

HOME PAGE: http://faculty.london.edu/hservaes/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Ane Miren Tamayo

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)20 78494689 (Phone)

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