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

See all articles by Cesare Fracassi

Cesare Fracassi

University of Texas at Austin

Gregory Weitzner

University of Texas at Austin - Department of Finance

Date Written: May 23, 2019

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 (May 23, 2019). 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)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

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