The Real Effects of Credit Ratings: The Sovereign Ceiling Channel

Abstract

We show that sovereign debt impairments can have a significant impact on financial markets and real economies through a credit ratings channel. Specifically, we find that firms reduce their investment and reliance on credit markets due to a rising cost of debt capital following a sovereign rating downgrade. We identify these effects by exploiting exogenous variation on corporate ratings due to rating agencies' sovereign ceiling policies that require firms' ratings to remain at or below the sovereign rating of their country of domicile.

Keywords: Credit ratings, Sovereign bonds, Sovereign ceiling, Cost of capital, Investment, Capital structure

JEL Classification: G24, G28, G31, G32, H63