Do Corporate Bond Rating Revisions Convey Information About Earnings?

Abstract

We study the information content that corporate bond rating revisions convey regarding future earnings. Consistent with previous findings, we find that rating downgrades are associated with negative abnormal stock returns, while rating upgrades appear to be nonevents. For rating downgrades, earnings decline in the two years prior to and in the year of the rating downgrade announcement but increase in the year following the rating downgrade. While rating upgrades follow a period of rising earnings, they do not signal any increase in future earnings. These results, in conjunction with our multivariate regression results, indicate that rating agencies respond more to permanent changes in cash flows and provide little information, if any, about future cash flows.

Keywords: Bond rating revisions, Earnings information, Cash flow signaling hypothesis, Cash flow permanence hypothesis

JEL Classification: G10, G14