Firms' Use of Accounting Discretion to Influence Their Credit Ratings

Abstract

This paper examines whether firms that deviate from an empirically modeled ("expected") credit rating engage in earnings management activities, as measured by abnormal accruals and real activities earnings management. We then test whether such actions are successful in helping these firms move toward their expected credit ratings. We find evidence that firms that engage in income-increasing (-decreasing) earnings management activities and are below (above) expected ratings achieve future upgrades (downgrades). These results suggest that firms below or above their expected credit ratings may be able to move toward expected ratings through the use of directional earnings management.

Keywords: credit rating agencies, expected ratings, earnings management, accruals, real activities

JEL Classification: G24, M41