Credit Watch and Capital Structure
9 Pages Posted: 21 Apr 2013
Date Written: April 18, 2013
We study the capital structure reactions of firms that have been added to Standard & Poor’s CreditWatch list in order to test the role of credit ratings in firm financial decisions. Survey evidence by Graham and Harvey (2001) indicates that CFOs consider credit ratings as the second most important determinant of financing policy. If credit ratings are indeed important we should observe that firms facing a potential downgrade should react by reducing debt financing in an attempt to avert the potential rating downgrade. In the case of a potential upgrade, we should also observe a scaling back of debt financing to reinforce the rating upgrade. We find evidence for the latter but for potential downgrade firms, contrary to expectations, we find that these firms issue more debt relative to equity. Overall, we conclude that while credit ratings maybe a consideration in determining corporate financing policy, it is probably a secondary determinant.
Keywords: Credit watch, credit ratings, capital structure
JEL Classification: G14, G24, G32
Suggested Citation: Suggested Citation