Do Firms Target Credit Ratings or Leverage Levels?
38 Pages Posted: 22 Mar 2005 Last revised: 5 Mar 2009
Date Written: October 5, 2005
Firms reduce leverage following credit rating downgrades. In the year following a downgrade, downgraded firms issue approximately 1.5-2.0% less net debt relative to net equity as a percentage of assets compared to other firms. This relationship persists within an empirical model of target leverage behavior. The effect of a downgrade is larger at downgrades to a speculative grade rating and if commercial paper access is affected. In particular, firms downgraded to speculative are about twice as likely to reduce debt as other firms. Rating upgrades do not affect subsequent capital structure activity, suggesting that firms target minimum rating levels.
Keywords: Leverage, Capital Structure, Debt, Credit Ratings, Tradeoff Theory
JEL Classification: G32
Suggested Citation: Suggested Citation