The Real Effects of Credit Ratings: Evidence from Corporate Asset Sales
78 Pages Posted: 10 Nov 2016 Last revised: 23 Jun 2017
Date Written: June 22, 2017
When credit rating agencies (CRAs) downgrade corporate debt, they may inadvertently aggravate credit constraints, but may also act as dedicated monitors who implicitly impose discipline on management to improve the allocation of productive assets. We investigate which, if any, effect dominates. Following downgrades, firms are more likely to conduct asset sales, particularly those with the self-reported purpose to pay down outstanding debt or raise cash. Downgrades affect the likelihood of asset sales to a much lesser extent when the purpose is to concentrate on core assets or to sell underperforming operations and do not affect the likelihood of non-cash generating spinoffs. Stock price reactions to asset sales following a downgrade suggest that sellers aim to relax credit constraints whereas buyers benefit from cash-in-the-market prices. Asset sales following downgrades are concentrated in segments with the highest liquidity, generate the lowest current cash flows, and have the most growth opportunities. Peer-based and intra-firm performance rank or relatedness to core activities, do not explain the choice of divested segments. Our results suggest that asset sales are a likely response to credit rating downgrades and aim to relax credit constraints, not to improve the allocation of the firm’s assets.
Keywords: Credit Ratings, Asset Sales, Financial Distress, Governance
JEL Classification: G34
Suggested Citation: Suggested Citation