Delayed Credit Rating Changes,
Firm Financing and Firm Performance

Abstract

Motivated by the insufficient research in understanding the influences of the delayed changes in credit ratings, the practical importance of information asymmetry as well as the theoretical difficulty of measuring information gap with an appropriate proxy, this thesis regards delayed credit rating change (DCRC) as a source of asymmetric information and exploits whether and how it affects issuer’s capital structure adjustments. It uses Compustat North America quarterly data from 1985 to 2010 inclusive.

Rating agencies often delay updating credit ratings, leading to an information gap between bond issuers and the market. This offers issuers (market insiders) opportunities to utilise the delayed credit rating changes as superior information, alongside which, factors capturing the associated benefits and costs of the rating changes and capital structure adjustments, are addressed to form the three key interactive variables in this research: DCRC, capital structure adjustments and firm performance.

First considered are the effects of information asymmetry on financing adjustment before DCRCs. The evidence shows that issuers often adjust debt and equity financing at least one quarter before rating change announcements published by rating agencies. Issuers who anticipate rating upgrades in the next quarter do not significantly change the net debt issuance. Issuers who anticipate rating downgrades increase net debt issuance before rating changes. Secondly, this research is concerned with the robustness of DCRC’s effects, which is confirmed by various robustness check tests and incorporating DCRC into tests of the existing capital structure theories. The result confirms DCRC’s robust effects on firm financing adjustments. The last issue addressed is the relation between information asymmetry and gains or losses to issuers when utilising the information asymmetry. The results suggest that information asymmetry does bring material effects on firm performance. The three groups of results form a mechanism of delayed credit rating change’s real effects and reveal a fresh explanation for issuer’s financing decision making under asymmetric information.