Credit Ratings and Capital Structure
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Credit Ratings and Capital Structure
Credit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital StructurenomicsThis Draft: April 20, 2004♦ 1 would like to thank Wayne Person, Charles Hadlock, Jonathan Karpoff. Jennifer Koski. Paul Malatesta, Mitchell Peterson, and especially Edward Rice, as well as seminar participants at Boston College, Indiana University, Northw estern University, Rice University, Un Credit Ratings and Capital Structureiversity of Pittsburgh, University of Virginia, University of Washington, West Virginia University, Xavier University, and the 2004 American Finance ACredit Ratings and Capital Structure
ssociation meetings, for helpful comments. Please address inquiries to Dairen J. Kisgen, Doctoral Candidate. University of Washington School of BusineCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structure and Capital StructureAbstractThis paper examines whether and to what extent credit ratings directly affect capital structure decisions. The motivation for this study begins with the observation that corporate financial managers care about credit ratings. Graham and Harvey (2001) find that credit ra Credit Ratings and Capital Structuretings are the second highest concern for CFOs when considering debt issuance. The paper outlines discrete costs and benefits associated with firm credCredit Ratings and Capital Structure
it rating differences, and tests whether concerns for these costs and benefits directly affect financing decisions. Using two distinct measures, firmsCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structure whether firms that are near a change in rating issue less debt over a subsequent period when compared to a control group. Results show that concerns about upgrades or downgrades of bond credit ratings directly affect managers’ capital structure decisions. Firms near a change in credit rating issue Credit Ratings and Capital Structure(retire) annually up to 1.5% less (more) debt relative to equity as a percentage of total assets than firms not near a change in rating. Prior evidencCredit Ratings and Capital Structure
e suggests that credit ratings affect asset valuations in the financial marketplace; this paper takes the next step and analyzes to what extent they aCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structureg by financial managers, rhe paper outlines the reasons why credit ratings may be relevant for managers in the capital structure decision process, and then empirically tests the extent to which credit rating concerns directly impac I managers' debt and equity decisions. The paper also examines how t Credit Ratings and Capital Structurehese findings complement existing capital structure theories such as the pecking order and tradeoff theories, and specifically how credit rating factoCredit Ratings and Capital Structure
rs can be included in empirical tests of capital structure theories.The initial empirical tests of this paper examine whether capital strut lure decisCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structureersus not being close to a downgrade or upgrade. Then controlling for firm-specific factors, I test whether firms that are near a change in rating issue less net debt relative to net equity over a subsequent period when compared to the control group. I find that concerns about upgrades or downgrades Credit Ratings and Capital Structure of bond credit ratings directly affect managers’ capital structure decision making; firms near a change in credit rating issue (retire) annually up tCredit Ratings and Capital Structure
o 1.5% less (more) debt relative to equity as a percentage of total assets than firms not near a change in rating. Finns with a credit rating designatCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structurepecific rating (e.g., BB-) based on credit quality determinates, the lop third and lower third of films within ratings also issue less debt relative to equity than films that arc in the middle of their individual ratings.These results do not appear to be explained with traditional theories ol capita Credit Ratings and Capital Structurel struc ture, and thus this paper enhances the capital structure decision theoretical and empirical frameworks. To my knowledge, this is the first papCredit Ratings and Capital Structure
er to show that credit ratings directly affect capital structure decision-making.1The influence of credit ratings on capital structure is economicallyCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structure only, and whether control variables are included. The relationship holds when both an OLS regression approach is used for continuous capital structure dependent variables and when a logit regression is used to examine binary capital structure choices. The relationship holds for both large and small Credit Ratings and Capital Structure firms, and for firms at several credit rating levels.After the initial tests in the paper establish these facts, subsequent empirical tests nest credCredit Ratings and Capital Structure
it rating factors into previous capital structure tests, such as those in Fama and French (2002) and Shyam-Sunder and Myers (1999). Dummy variables, iCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structurepers.The motivation for this study begins with the observation that corporate financial managers care about credit ratings. Graham and Harvey (2001) find that credit ratings are the second highest concern for CFOs when considering debt issuance. When asked what factors affect how they choose the app Credit Ratings and Capital Structureropriate amount of debt for their firm, Graham and Harvey found that 57.1% of CFOs said that “Our credit rating (as assigned by credit rating agenciesCredit Ratings and Capital Structure
)” was important or very important. "Financial flexibility” was the only category higher, with 59.4%, and therefore credit ratings ranked higher than Credit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structure indicate how the survey results support or contradict various capital structure theories. In this discussion the credit rating result only appears where they argue it might support the tradeoff theory: “credit ratings [concern]...can be viewed as an indication of concern about distress” (pg. 211). Credit Ratings and Capital StructureMolina (2003) argues that to the extent credit ratings are a2https://khothuvien.cori!measure of financial distress, the large effect of capital structCredit Ratings and Capital Structure
ure on ratings helps explain to some extent why firms are underlevered (as argued by Graham (2000), for example).The arguments and results of this papCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structure results are apparent in both instances, whereby firms near both an upgrade and downgrade issue less debt than firms not near a change in rating. This behavior for firms near an upgrade is inconsistent with distress arguments but consistent with credit rating effects. I also include variables in the Credit Ratings and Capital Structure empirical tests that control for the financial condition of the firm to account for distress concerns. Credit rating effects are also examined for fiCredit Ratings and Capital Structure
rms at all ratings levels, and the results are consistent across the ratings spectrum with significant credit rating effects at the AA rating level alCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structure has been conducted examining how credit ratings affect stock and bond valuations. Hand, Holthausen and Leftwich (1992) find statistically significant negative average excess bond and stock returns upon the announcement of downgrades of straight debt. Ederington, Yawitz and Roberts (1987) and West ( Credit Ratings and Capital Structure1973) find that credit ratings are significant predictors of yield to maturity beyond the information contained in publicly available financial variabCredit Ratings and Capital Structure
les and other factors that would predict spreads. Ederington and Goh (1998) show that credit rating downgrades result in negative equity returns and tCredit Ratings and Capital StructureDarren J. Kisgen*University of Washington School of Business AdministrationDepartment of Finance and Business Econ Credit Ratings and Capital Structuref the “downgrade itself - not to earlier negative information or contemporaneous earnings numbers.” Thus evidence exists that suggests credit ratings are significant in the financial marketplace; this paper takes the next step and analyzes to what extent they are significant in capital structure dec Credit Ratings and Capital Structureision making.3The rest of this paper is organized as follows. In Section I, I provide explanations for why credit ratings might factor into managerialCredit Ratings and Capital Structure
capital structure decisions. In Section II. I detail how-credit rating concerns complement existing theories of capital structure. Section III contaiGọi ngay
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