What's in a Debt? Rating Agency Methodologies and Firms’ Financing and Investment Decisions

68 Pages Posted: 31 Dec 2016 Last revised: 8 Feb 2023

See all articles by Cesare Fracassi

Cesare Fracassi

University of Texas at Austin

Gregory Weitzner

McGill University

Date Written: March 18, 2020

Abstract

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

Fracassi, Cesare and Weitzner, Gregory, What's in a Debt? Rating Agency Methodologies and Firms’ Financing and Investment Decisions (March 18, 2020). Available at SSRN: https://ssrn.com/abstract=2891425 or http://dx.doi.org/10.2139/ssrn.2891425

Cesare Fracassi

University of Texas at Austin ( email )

McCombs School of Business
2110 Speedway Stop B6600
Austin, TX 78712-1276
United States
512-232-6843 (Phone)

HOME PAGE: http://https://faculty.mccombs.utexas.edu/cesare.fracassi/

Gregory Weitzner (Contact Author)

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

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