Do Credit Rating Agencies Value Less Volatile Leverage?

56 Pages Posted: 19 Apr 2021

See all articles by Boochun Jung

Boochun Jung

University of Hawaii at Manoa - School of Accountancy

Tae Wook Kim

The University of Hong Kong

Miaochan Li

University of Hawaii at Manoa - UNIVERSITY OF HAWAII - Shidler College of Business

Derrald Stice

University of Hong Kong - HKU Business School

Date Written: April 15, 2021

Abstract

Prior studies investigating financial statement volatility focus primarily on the volatility of income statement items, earnings volatility in particular, while our knowledge of the effects of the volatility of balance sheet items remains limited. We focus on leverage, arguably the most important balance sheet item ratio, and we investigate how credit rating agencies assess firms with smoother leverage ratios. We document that after controlling for a variety of firm characteristics, including the level of leverage and free cash flow, credit ratings are negatively related to leverage volatility. These results suggest that one benefit for firms with lower leverage volatility is a more favorable credit rating. We also examine the characteristics of firms with a greater ability to smooth leverage ratios. We find a negative relation between financial reporting quality and leverage volatility, consistent with the idea that higher financial reporting quality provides firms with better access to both equity and debt financing, providing greater flexibility to smooth leverage than firms with lower financial reporting quality.

Keywords: Leverage Volatility, Leverage, Credit Ratings, Financial Reporting Quality

JEL Classification: G24, G32, M41

Suggested Citation

Jung, Boochun and Kim, Tae Wook and Li, Miaochan and Stice, Derrald, Do Credit Rating Agencies Value Less Volatile Leverage? (April 15, 2021). Available at SSRN: https://ssrn.com/abstract=3827565 or http://dx.doi.org/10.2139/ssrn.3827565

Boochun Jung

University of Hawaii at Manoa - School of Accountancy ( email )

College of Business Administration
Honolulu, HI 96822
United States

Tae Wook Kim

The University of Hong Kong ( email )

Hong Kong

Miaochan Li

University of Hawaii at Manoa - UNIVERSITY OF HAWAII - Shidler College of Business ( email )

2404 Maile Way
Honolulu, HI 96822
United States

Derrald Stice (Contact Author)

University of Hong Kong - HKU Business School ( email )

Accounting Area
Hong Kong, HK
China

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