The role of credit ratings on capital structure and its speed of adjustment: an international study

Abstract

Using an international dataset, we examine the role of issuers' credit ratings in explaining corporate leverage and the speed with which firms adjust toward their optimal level of leverage. We find that, in countries with a more market-oriented financial system, the impact of credit ratings on firms' capital structure is more significant and that firms with a poorer credit rating adjust more rapidly. Furthermore, our results show some striking differences in the speed of adjusting capital structure between firms rated as speculative-and investment-grade, with the former adjusting much more rapidly. As hypothesized, those differences are statistically significant only for firms based in a more market-oriented economy.

Credit Rating as a Mechanism for Capital Structure Optimization: Empirical Evidence from Panel Data Analysis

“…Moreover, the degree to which credit rating assessments influences capital structure choices can be evaluated directly or inserted into conventional capital structure theories (Duff and Einig 2009;Kisgen and Strahan 2010;Wojewodzki et al 2017).…”

“…There are a growing number of empirical studies that scrutinize the effects of credit rating changes on the decisions of capital structure (Naeem 2012;Matthies 2013;Wojewodzki et al 2017). Credit rating agencies have access to various types of information, such as the business plan of firms, capital expenditure, and the dividend policy designed for future that is not provided to investors, etc.…”

Rating and capital structure: How do the signs affect the speed of adjustment?

“…In accordance with Wojewodzki et al. (), with this model, we avoid the potential problem of simultaneity between credit ratings and corporate leverage.…”

“…In this respect, Wojewodzki et al. () show that the credit rating level is negatively associated with the leverage ratios and that firms with a low rating adjust their capital structure more quickly than firms with a better credit rating. Similarly, Mittoo and Zhang () find that firms with a BB rating or below (low credit quality firms) have leverage that is approximately nine percentage points higher than those firms with a BBB rating or above (high credit quality firms), even after controlling for the credit quality effect.…”

“…In this respect, Huang and Shen () find that the effect of a credit rating change is more pronounced in countries with good legal and institutional characteristics than in countries with poor legal and institutional characteristics, whereas Wojewodzki et al. () conclude that in countries with a more market‐oriented financial system, the impact of credit ratings on firms’ capital structure is more significant than it would be in a bank‐based country.…”