What's in a Debt? Rating Agency Methodologies and Firms’ Financing and Investment Decisions
62 Pages Posted: 31 Dec 2016 Last revised: 25 May 2019
Date Written: May 23, 2019
In July 2013, Moody's unexpectedly increased the amount of equity credit that speculative-grade firms receive for preferred stock from 50% to 100%. Firms affected by the rule change were suddenly considered less levered by Moody's even though their balance sheets did not change. These firms responded by issuing debt, targeting a leverage ratio as defined by Moody's, and growing their assets. The rule change transferred value from bond to equity holders, and led to an increase in preferred stock issuance. How rating agencies assess risk thus has a significant causal impact on firms' financing, investment, and security design decisions.
Keywords: Rating Agencies, Capital Structure, Leverage Targeting, Rating Targeting
JEL Classification: G24, G32
Suggested Citation: Suggested Citation