Asymmetric Information and Credit Quality: Evidence from Synthetic Fixed-Rate Financing

Abstract

In this article the usage of synthetic fixed-rate financing (SFRF) with interest rate swaps (i.e., borrowing short-term and using swaps to hedge interest rate risk, instead of selecting conventional fixed-rate financing) by Fortune 500 and S&P 500 nonfinancial firms is examined over the period 1991 through 1995. Credit ratings, debt issuance, and debt maturities of these firms are monitored through 1999. Strong evidence is found supporting the asymmetric information theory of swap usage as described by Titman (1992), even after controlling for industry, credit quality, size effects, and the simultaneity of the capital structure and the interest rate swap usage decision. Consistent with theoretical predictions, SFRF firms are more likely to undergo credit quality upgrades. When limiting the sample to firms where asymmetric information costs are potentially the greatest, the results are even stronger. These findings are important because they document that swaps serve a highly valuable service for firms subject to information asymmetries.

Keywords: Interest rate swap, Credit quality, Asymmetric information, Debt maturity, Capital structure

JEL Classification: G30