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Split Bond Ratings and Information Opacity Premium
Abstract
This paper examines the relationship between split bond ratings and bond yields at the notch level for newly issued corporate bonds. We find that split rated bonds average a 7-basis-point yield premium over nonsplit rated bonds of similar credit risk. The yield premium increases from 5 basis points for one-notch splits to 15 (20) basis points for two-notch (three-notch) splits. These findings indicate that investors demand higher yields for split rated bonds to compensate for the information opacity of such bonds. In addition, the yield premium for split rated bonds is higher during economic recessions, indicating investors are more risk averse during economic downturns. Consequently, split ratings impose higher borrowing costs for firms, especially during economic downturns.
... In line with prior studies, the measure of credit rating is translated from an alphanumerical format to a quantitative measure across the scale of Aaa/AAA/AAA (on the Moody's, S&P, and Fitch rating scales respectively) are assigned a value of 1, while C/C ratings are assigned a value of 21 (Livingston et al., 2008;Livingston & Zhou, 2010). To measure the rating disagreement, this study follows prior studies in measuring disagreement in initial corporate bonds ratings Bonsall & Miller, 2017;Morgan, 2002). ...
... In addition, a firm with a high credit rating may feel more comfortable disclosing more detailed pension information as this could enhance their creditworthiness and potentially result in a higher rating. Lastly, firms may choose to disclose more detailed pension information to reduce the level of credit rating disagreement, which can create uncertainty that arises from having higher information opacity problems and consequently higher information asymmetry between firms and investors (Livingston & Zhou, 2010). The quality of disclosure among firms is highly variable and depends on the cost of information. ...
Accounting standard-setting bodies and regulators have imposed requirements to improve pension accounting regulations and disclosure practices due to the importance and materiality of defined benefit pension plans. In particular, IAS 19R was recently amended to address the excessive risk-taking in pension plan investments. In addition, academics, and practitioners have stressed the importance of high-quality and transparent disclosure to improve the usefulness of information aimed at stakeholders. Drawing on theories such as agency theory, positive accounting theory, stakeholder salience theory, collective bargaining theory, signalling theory, and behavioural decision theory, the study addresses three key research questions along two axes: the implications of accounting regulations on pension investment decisions followed respectively by the determinants and consequences of pension disclosure practices. Therefore, this study first examines the economic consequences of IAS 19R on pension asset allocations and the moderating role of firm financial distress by relying on a sample of European listed firms affected by IAS 19R, compared to a control group of US firms that share similar firms characteristics but are unaffected by the standard between 2009 and 2014. Second, by relying on an automated content analysis approach to evaluate the specificity of defined benefit pension plan information for 119 FTSE350 listed firms over the period 2017 to 2019, the study examines whether a firm’s unionisation level has an impact on the quality (specificity) of pension information in the strategic report and whether this relationship is moderated by the level of cash holdings. Thirdly, the study considers whether the pension information specificity affects credit rating agencies' (CRAs) decisions. It also examines whether and how pension information specificity influences credit rating disagreement between CRAs.Respectively, the analysis reveals firms shifted out of equities during the post-IAS 19R period, especially if they were in financial distress. Some firms allocated pension plans to other asset classes, but the types of asset classes being reallocated varied across countries, suggesting that the economic consequences of IAS 19R on pension asset allocations are influenced by firms’ financial health and the country’s pension welfare system. Subsequently, the study found that while the strategic report became lengthier, there was a decline in the quality (specificity) of pension information. However, a higher unionisation rate improved the quality of pension disclosure, suggesting that trade unions are seen as salient stakeholders who can influence firms' disclosure strategies; especially if firms hold high cash levels that enhance employees-employers trust. Finally, there is a significantly negative association between the level of pension information specificity in the firm's strategic report and credit rating decisions, suggesting that higher pension information specificity is associated with a lower credit rating or downgrading. There is also evidence that greater pension information specificity reduces rating disagreement, particularly when the ratings are two notches or higher. Overall, standard-setting bodies and practitioners should consider the role of the dimension of social welfare characteristics in the allocation of pension plans to different asset classes, which may result in shifting rather than mitigating pension risk within the pension plan. Furthermore, regulators should pay attention to firms' disclosure strategies when they face salient stakeholders to accommodate their demands which may cause inconsistency in reporting behaviour resulting in a lack of information transparency to all stakeholders
... Of this number, 55 banks, 221 non-bank financials and 636 non-financial firms received at least one rating downgrade by Moody's or S&P. Furthermore, we impose a restriction that firms need to be rated by both Moody's and S&P at the same time as the literature shows that investors request a compensation for the greater uncertainty of split-rated bonds (Thompson and Vaz, 1990;Livingston and Zhou, 2010). Therefore, controlling for split ratings seems necessary. ...
... Split rating -Dummy variable that equals 1 when a downgrade results in a different rating between Moody's and S&P Stock market reaction to split ratings has not yet been studied. The bond market reaction to split ratings has already been investigated for nonfinancial corporate bonds and shows that investors request compensation for the greater uncertainty of split-rated bonds (Thompson and Vaz, 1990;Livingston and Zhou, 2010). ...
... In addition, we control for various bond features: Bond Maturity, Issue Amount, Callable dummy, Putable dummy, Sinking Fund dummy, Senior Bond dummy. It is well documented in prior literature that bond features are significant determinants of offering yields (see, for example, Livingston and Zhou, 2010 ). 29 In this section, we limit our sample to bonds with fixed coupon rates. ...
... Kidwell et al. (1984) investigate a sample of US industrial and utility bonds from 1982 to 1983. Sironi (2003) a Livingston and Zhou (2010) b Kidwell et al. (1984) ...
We investigate the nascent but fast-growing Chinese bond market and credit rating industry. We find Chinese bond ratings are informative and significantly correlated with bond offering yields. In addition, the Chinese bond investors distinguish ratings from different credit rating agencies (CRAs), demanding lower yields on bonds rated by global-partnered CRAs. However, the empirical results suggest that the rating scales used by Chinese CRAs are not comparable to those of international CRAs. Furthermore, Chinese CRAs have very broad rating scales and pool bonds with significantly different default risks into a single rating category, resulting in over 90% of bonds in only three rating categories.
... If less readable filings result in greater uncertainty, we expect to observe increases in the cost of debt. The impact of complex reporting could affect credit spreads either through the potential increase in rating agency disagreement, as documented by Livingston and Zhou (2010), or more directly through the higher processing costs faced by investors. ...
... Thus, we next focus on H3, which predicts that poorer disclosure readability will be associated with wider offering credit spreads (i.e., high cost of debt) for newly issued bonds. Given that prior research has documented that credit rating levels (Ziebart and Reiter 1992) and disagreement (Livingston and Zhou 2010) affect offering credit spreads, it is plausible that any effect of readability on the cost of debt is mediated by rating levels and disagreement. In addition, there could still be a direct channel through which readability affects the cost of debt if bond investors' uncertainty regarding default risk and recovery given default changes as a result of their own information processing. ...
Prior research on the determinants of credit ratings has focused on rating agencies’ use of quantitative accounting information, but the there is scant evidence on the impact of textual attributes. This study examines the impact of financial disclosure narrative on bond market outcomes. We find that less readable financial disclosures are associated with less favorable ratings, greater bond rating agency disagreement, and a higher cost of debt. We improve causal identification by exploiting the 1998 Plain English Mandate, which required a subset of firms to exogenously improve the readability of their filings. Using a difference-in-differences design, we find that the firms required to improve the readability of their filings experience more favorable ratings, lower bond rating disagreement, and lower cost of debt. Collectively, our evidence suggests that textual financial disclosure attributes appear to not only influence bond market intermediaries’ opinions but also firms’ cost of debt.
... In addition, we control for various bond features: Bond Maturity, Issue Amount, Callable dummy, Putable dummy, Sinking Fund dummy, Senior Bond dummy. It is well documented in prior literature that bond features are significant determinants of offering yields (see, for example, Livingston and Zhou, 2010 ). 29 In this section, we limit our sample to bonds with fixed coupon rates. ...
... Kidwell et al. (1984) investigate a sample of US industrial and utility bonds from 1982 to 1983. Sironi (2003) a Livingston and Zhou (2010) b Kidwell et al. (1984) ...
We investigate the nascent but fast-growing Chinese bond market and credit rating industry. We find Chinese bond ratings are informative and significantly correlated with bond offering yields. In addition, the Chinese bond investors distinguish ratings from different credit rating agencies (CRAs), demanding lower yields on bonds rated by CRAs with better reputations and more stringent rating standards. However, the empirical results suggest that the rating scales used by Chinese CRAs are not comparable to those of international CRAs. Furthermore, Chinese CRAs have very broad rating scales and pool bonds with significantly different default risks into a single rating category, resulting in over 90% of bonds in only three rating categories.
... Morgan (2002) shows that Moody's and S&P have higher proportions of split ratings in industries with greater information opacity. Livingston and Zhou (2010) use split bond ratings between Moody's and S&P as a proxy for information opacity and find that split-rated bonds average a seven-basis-point yield premium over non-split-rated bonds of similar credit risk. The yield premium increases with wider splits, a stronger indicator of information opacity. ...
... Second, the coefficient on Opacity Index is positive and highly significant, indicating that information opacity increases bond yields. This finding is consistent with previous studies on the link between information opacity and bond yields (Lu, Chen, and Liao 2010;Livingston and Zhou 2010). Most control variables have the expected signs, with the exception of the Senior Bond dummy. ...
We examine the marginal impact of Fitch ratings on the at-issuance yields of industrial and utility bonds rated by Moody's and Standard & Poor's. We find that Fitch ratings reduce the yield premiums on information-opaque bonds by about 30%, or 15 basis points. The finding is robust even when a Fitch rating exactly equals the two major ratings or their average. The findings suggest that Fitch ratings are not redundant but bring additional information to investors. Increased competition in the rating industry enhances the information efficiency of the bond market, and the existence of smaller rating agencies is economically justified.
... The (unreported) patterns in the extended sample are similar. 5 Moody's began issuing notch ratings after April 1982 (see, e.g., Livingston and Zhou (2010)). We start our sample period from 1992 because very few bonds were offered by PE-backed IPO companies from April 1982-1991. ...
... We follow the literature to choose the control variables in credit-rating and yield-spread regressions (e.g., Anderson et al. (2003), Livingston and Zhou (2010)). Table 1 provides the detailed definitions and the summary statistics (means, medians, and standard deviations) of these variables. ...
A popular view is that private equity (PE) firms tend to expropriate other stakeholders of their portfolio companies. Bonds offered during 1992-2011 by companies after their initial public offerings (IPOs) do not reflect this view. We find that yield spreads on bonds offered by PE-backed companies are, on average, 70 basis points lower, holding other things constant. We also find that PE-backed companies have more conservative investment and dividend policies after bond offerings compared with non-PE-backed companies. These results suggest that PE firms' reputational concerns dominate their wealth expropriation incentives and help their portfolio companies reduce the costs of debt. Copyright © Michael G. Foster School of Business, University of Washington 2016.
... If fewer readable filings lead to higher uncertainty, it is expected to see an increase in the cost of debt. Livingston and Zhou (2010) found that complex reporting could affect credit spreads by increasing the likelihood of disagreement among rating agencies or directly optimizing the processing expenses incurred by investors. Financial statement readability does not appear to be associated with a higher cost of equity, even though narrative indicators that convey performance expectations are associated with higher equity costs (Kothari et al., 2009). ...
Purpose
This study investigates the impact of managerial ability and auditor report readability on the cost of debt and corporate liquidity in Omani-listed industrial companies.
Design/methodology/approach
The study uses data from the S&P Capital IQ database and audited annual reports published on Muscat Securities Market. The sample consists of 35 firms (175 firm-year observations) from 2015 to 2019. Managerial ability is measured using the data envelopment analysis proposed by Demerjian et al . (2012a, b). Auditor report readability is measured as a log of the auditor report digital file size proposed by Loughran and McDonald (2014).
Findings
This study finds that a company's managerial ability reduces the cost of debt lending support to upper echelons and agency theory. Highly able managers of industrial companies are associated with increased corporate liquidity consistent with the precautionary motive of holding cash. In addition, less-readable auditor reports contribute to higher debt costs and reduce corporate liquidity.
Originality/value
To the best of the authors’ knowledge, few studies have explored the influence of managerial ability and auditor reporting readability on firms' financial policy. For industrial-sector firms, this study demonstrates the managerial ability and readability of auditor readability as significant determinants of the cost of debt and corporate liquidity, especially during periods of uncertainty. Thus, the findings can be generalized to other non-financial sector firms in the country and the Middle East.
... Among others, Norden and Weber (2004), Hull et al. (2004), Galil and Soffer (2011), and Lee et al (2018) show that downgrades follow changes to the CDS, bond, and stock markets. Some show that rating events can be predicted based on previous rating disclosures (see for instance Alsakka and Gwilym 2010 for the sovereign market), or by the level of ratings and disagreements between rating agencies (Livingston andZhou 2010, Bongaerts et al. 2012). The present study contributes to this stream of work by proposing a single theoretical framework to explain these different empirical patterns. ...
Do rating announcements reduce information asymmetries? We investigate the effect of rating disclosures on the volatility and liquidity of the US bond market. Although rating agencies' decisions often are anticipated by credit spread changes, we show that in the case of no regulatory change their release can reduce volatility and the bid‐ask spread. This reduction is stronger when the rating agency announcement has been anticipated by the market, namely, after downgrades, whereas upgrades trigger mixed reaction. These findings are consistent with the predictions of a simple sequential trade model with event uncertainty, and noise and informed traders. This article is protected by copyright. All rights reserved
... bad performance) by providing a complex report text. The results of this support the findings of previous studies (Livingston and Zhou, 2010;Bonsall and Miller, 2017;Ertugrul et al., 2017)that provide evidence on the negative consequences of providing users/creditors with less readable annual reports. Mainly, our findings support our hypothesis that firms with less readable annual reports will have a relatively high cost of debt. ...
Companies use disclosure as a strategy to transfer and communicate selected information to stakeholders. This study examines the association between the firm's textual disclosure strategy and cost of debt by looking at the tone and readability of Management Discussion and Analysis (MDandA) reports and using a sample of 1596 Indonesian listed companies from all industries except the financial industry, from 2011 to 2018, and using ordinary least square (OLS) regression to test the research hypotheses. The findings suggest that both negative tone and poor readability level are associated positively with the cost of debt. This paper contributes to knowledge of the important aspects firms need to consider when setting their disclosure strategies, mainly how the tone and readability of firms' annual reports may be interpreted by users/creditors and affect the amount they will charge the firm for debt.
... Credit rating downgrade of instrument, especially to non-investment grade, could be negative for hospitals' finance. If a hospital loses its investment grade, it impacts its ability to borrow money and current debt holders of their bonds (Livingston and Zhou, 2010). Downgrading credit rating is very harmful for business; it restricts the magnitude of borrowings. ...
... Credit rating downgrade of instrument, especially to non-investment grade, could be negative for hospitals' finance. If a hospital loses its investment grade, it impacts its ability to borrow money and current debt holders of their bonds (Livingston and Zhou, 2010). Downgrading credit rating is very harmful for business; it restricts the magnitude of borrowings. ...
... If debt providers face uncertainty in estimating the true value of a borrowing firm or its cash flow, it will become difficult for them to estimate its real default risk (Duffie & Lando, 2001;Lu, Chen, & Liao, 2010). Such difficulty is reflected on a wider estimate of a firm's range of default risk (Livingston & Zhou, 2010;Yu, 2005) and, hence, cost of debt. ...
Using hand‐collected data on the level of pension‐related mandatory disclosures required by International Accounting Standard 19 Employee Benefits , we test whether compliance levels with these disclosures convey information that affects firms’ access to the public instead of the private debt market, as well as the cost of their new debt issues. We document a higher tendency to access the public debt market for firms with higher levels of pension‐related disclosure. Furthermore, we find that firms with higher levels of pension‐related disclosure enjoy a lower cost in terms of issuance of public debt, but not a lower cost for private debt issues. Thus, the benefits of disclosure in reducing information risk are only realisable when creditors rely heavily on financial statements in their decision making, due to the limited access to private information. Additional tests reveal that high compliance levels effectively mitigate the negative effect of pension deficits on the cost of public debt. These findings provide novel evidence in the extant literature on the role of mandatory (and, in particular, pension‐related) disclosures on firms’ debt financing. They also have important policy implications.
This article is protected by copyright. All rights reserved
... As a government agency directly appointed by the State Council the CBRC is responsible for the supervision and regulation of commercial banks and has adopted a series of cautious steps to improve the banks' asset quality and enhance their anti-risk ability. 2 1 In stock markets, the research establishes a negative relation between stock returns and the dispersion of analysts' earnings forecasts (Diether et al. 2002). In bond markets, it shows that the information opacity contained in split ratings is a risk factor in bond pricing (Güntay and Hackbarth 2010;Livingston and Zhou 2010). Other related studies include Bonaccorsi di Patti and Dell'Ariccia (2004) who identify a positive relation between rating splits and other commonly applied opacity measures such as the share of fixed assets in the balance sheet, and Livingston et al. (2008) who confirm that split-rated bonds are more likely to have rating changes after the initial bond issuance. ...
We use survey data from the China Banking Regulatory Commission to construct a proxy for a firm’s opacity to examine its causes and influences. Our opacity proxy is positively associated with the distance between firms and banks, the geographic dispersion of business groups, and the size of the intra-group guarantee. Firms with higher opacity have a higher default probability particularly given a poor credit history or membership in a business group with low quality credit. Our evidence, which is robust to different model specifications, confirms that the borrower’s opacity can reduce the efficiency of bank monitoring. Our study indicates that loan officers have a good idea of the borrower’s opacity, and their professional opinions effectively reflect this perception.
... Such a divergence could have increased investors' uncertainty regarding an issuer's creditworthiness, and decreased the information content of a rating change announcement by a particular rating agency. Prior studies contradicted this reasoning, as they detected stronger price effects for split ratings compared to concordant rating changes (e.g., Gropp and Richards, 2001;Livingston and Zhou, 2010). ...
Wealth transfer effects between company owners and lenders based on changes in a firm’s credit rating have primarily been examined a) for one type of security; b) on U.S. capital markets; and c) by applying standard event study methods. In contrast to these studies, we compared the price effects of stocks and corporate bonds of the same issuer using robust event study methods. Our findings indicated that downgrades cause negative price effects for owners and lenders of European firms, whereas upgrades only induced positive price effects for lenders. However, we did not find evidence for the existence of wealth transfer effects between owners and lenders on European capital markets.
The paper aims to determine the effect of split ratings on corporate bond yields. A Two-Sample t-Test was conducted for each risk category of bonds to assess the impact of split ratings. Using a sample of corporate bonds issued between January 2000 and May 2023, the study finds evidence that split-rated bonds exhibit higher yields. This suggests that investors demand greater compensation for the risk associated with split ratings, which stems from the informational opaqueness and uncertainty surrounding these instruments. The research also reveals that the magnitude of the difference between split ratings affects bond yields, with larger gaps leading to higher yields. The findings have significant implications for investors and issuers, emphasising the need to carefully evaluate split-rated bonds and consistent credit ratings. By enhancing our understanding of the relationship between split ratings and bond yields, this research promotes transparency and informed decision-making in the corporate bond market.
Purpose
To determine the effect that covenants have on the credit ratings assigned by the two major agencies.
Design/methodology/approach
The authors examine 1,822 bond issues from 1991 to 2018, with a two-stage methodology to account for the endogeneity of the firms' choices and the ordinal nature of the ratings. The authors use Hendry's model selection method to find the best-fitting models from 37 control variables; the final models feature 20–24 orthogonalized variables, all significant at 5% and most at 1%.
Findings
The study’s results suggest that restrictive covenants positively affect ratings, particularly for bonds on the border of junk and investment grade. However, this effect appears to be decreasing with time, suggesting the financial crisis of 2008 has impacted ratings. Additionally, divergent covenant treatment leads to split ratings where the two agencies assign different levels of ratings on the same bonds. The study’s findings provide key insights into the factors that differentiate ratings given by each agency.
Practical implications
Managers must balance the perceived benefits of covenants against the costs, included lower credit ratings.
Originality/value
No other study has examined this issue controlling for both the ordinal nature of the ratings and the endogeneity in the decision to include specific covenants.
Purpose
This paper explores the impact of tone complexity on the cost of debt in the USA.
Design/methodology/approach
A sampling from 692 publicly nonfinancial-traded companies in the USA is employed over the period between 2010 and 2018. Generalized methods of moments (GMM) model is implemented to examine the impact of tone complexity on the cost of debt and its implications upon creditors and users.
Findings
The findings show that high-tone complexity is associated with a greater cost of debt. The use of a more complex tone in a company's annual reports has been shown to influence creditors' perceptions of risk.
Originality/value
This research pursues innovation by examining how creditors can use the tone complexity of annual report to assess the level of information asymmetry and estimate the required rate of return accordingly.
This paper contributes to accounting literature by reexamining the impact of the quantity and readability of annual report narratives on cost of capital. This study employs a machine learning technique, namely, the model-based (MOB) recursive partitioning, while the least absolute shrinkage and selection operator is used to select variables from a sample of 720 bank–¬¬¬¬¬year observations from eight Middle Eastern and North African countries between 2008 and 2019. The model-based (MOB) recursive partitioning works with local and global models to explore hidden information in the data that leads to better results in both linear and nonlinear relationships. Our analysis shows that, on one hand, the readability of annual report narratives has an insignificant impact on cost of capital. On the other hand, it shows that the greater the amount of narrative disclosure, the lower the cost of capital, a result that varies between countries and according to corporate profitability.
We examine the effect of voluntary disclosure on rating disagreement among credit rating agencies (CRAs). Previous empirical findings suggest that precise financial reporting decreases information risk and affects split ratings. However, no prior research has investigated the relationship between voluntary disclosure and split ratings, even though such disclosure can reduce information asymmetry. We find a negative relationship between voluntary disclosure and split ratings by CRAs. This study reveals voluntary disclosure that includes the manager's intentions (i.e., discretionary judgment) is a determinant of split ratings. In doing so the study contributes to the literature on the role of voluntary disclosure on CRAs.
This paper examines the effect of credit rating disagreements on merger and acquisition (M&A) decisions. We show that acquirers with split ratings prefer to use stock to finance their acquisitions. More importantly, we find that acquirers with split ratings experience lower announcement returns. Further analysis shows that overpayment by acquirers with split ratings is concentrated in acquirers with entrenched managers. Our results are robust to alternative identification strategies. Overall, our evidence indicates that credit rating disagreements are heavily priced in the M&A market.
The aims of this paper are know the definition, competence and the procedures of each learning models in English. The learning process at school is an educational process that is planned, integrated, and systematical coordinated with clear and firm evaluation standards and measures. By therefore, everything related to the process learning in schools is an interpreted whole cannot be separate and random. A curriculum there must be systematically connected with the methodology learning is used, while the methodology the lesson must also be formulated in details and details. Therefore, curriculum development on practice is always bound and is strongly connected with learning methodology.
The disagreements among credit rating agencies (split ratings) change over time, reflecting time varying nature in information opacity of firms. We analyse how the changes in information opacity affect the confidence in the reliability of ratings. We document that negative credit rating adjustments have a stronger impact on bond excess returns: (i) when the information opacity cuts down and (ii) with lower levels of information opacity. Investors seems to have more trust on the information disclosed by rating adjustment in those cases. The excess return response also depends on the credit rating level, being the dynamics of opacity relevant only for high yield (HY) bonds. The key results persist when alternative measures of rating agencies' disagreement are taken into consideration.
This paper analyses whether opacity of bank creditworthiness increases during crisis periods and if the conservativeness of CRAs changes through business cycles. Univariate and multivariate methodologies are used: data from Moody’s and S&P on credit ratings and watch status for 133 commercial banks across 17 developed countries from 2007 to 2015 is employed. The univariate analysis is a unique technique that provides a new perspective to assess whether splits between CRAs are defined as permanent or temporary. The evidence demonstrates that Moody’s and S&P frequently disagree. S&P is shown to be the more conservative CRA overall, however, the extent to which Moody’s issues higher ratings decreases over time until it becomes the more conservative CRA. The paper is the first of its kind to establish that the conservativeness of Moody’s and S&P changes throughout business cycles, which should impact on the strategic decision making of investors.
We examine the relationship between bank asset and informational quality. We use a diversified panel of 699 banks from 84 countries and measure opacity (lack of informational quality) with rating disagreements between issuer-specific ratings by three credit rating agencies (S&P, Moody’s and Fitch). Results from panel ordered logit regressions show that poor asset quality increases the probability of greater credit rating disagreements. Considering that the recent regulatory frameworks require from banks to reduce the worrying levels of non-performing loans and to increase transparency in their risk-taking, our findings have important policy implications.
Purpose
This paper aims to examine the relationship between the readability of annual reports and corporate performance in Qatari listed firms while controlling for a firm’s competitive position, governance structure and specific features such as size, age and industry type.
Design/methodology/approach
This study relies on both agency theory and legitimacy theory to develop testable hypotheses. It uses a sample of 126 firm-year listed companies in the Qatar Stock Exchange to test obfuscation in the annual reports through examining the association between the readability of Narrative Disclosures (NDs) and corporate profitability, financial risk and agency costs for the period from 2014-2016.
Findings
The findings show that firms with higher annual report readability are more profitable and have lower agency costs, which is an indication of the existence of “obfuscation.” Qatari firms may use narrative complexity as a disclosure strategy to enhance their image and consequently maintain their social legitimacy.
Research limitations/implications
Although the study findings suffer from limited global generalization, they can be generalized across Gulf Cooperation Council countries. Thus, future cross-country research is encouraged.
Practical implications
The findings encourage Qatari policymakers to instate a policy for “Plain English” writing to make NDs easy to read by international investors.
Originality/value
This study is one of very few studies that examines the readability of annual reports in emerging market economies, i.e. Qatar. The study contributes to the paucity of research that examines English-written annual reports in non-English speaking countries.
We analyze whether soliciting multiple ratings leads to lower syndicated loan spreads. Our results document that banks apply, on average, lower spreads to multi-rated firms. This effect depends on the reduction of information asymmetry about borrowers’ creditworthiness (information production hypothesis) and on the benefits in regulatory terms (regulatory certification hypothesis). In addition, consistent with the rating shopping hypothesis, we find that banks price the risk that borrowers shopped for better ratings, especially in crisis periods. Our results also hold when considering crisis periods, the unobserved heterogeneity of lenders, the use of rating-based pricing, and adopting a matched sample.
We examine the relation between a firm's equity R² and the pricing and design of its debt securities. We find that firms with less synchronous stock returns are associated with a higher cost of debt after controlling for default and liquidity risks. Bonds issued by low synchronicity issuers also experience larger price reactions to information signals provided by equity analysts. Further analysis demonstrates that lower synchronicity is associated with cross-sectional variation in the use of call provisions and with split S&P and Moody's bond ratings. Contrary to conventional interpretation, these results suggest that low R² reflects inferior information transparency and higher information risk.
This study finds that better reporting quality is associated with less uncertainty about credit risk as captured by disagreement among the credit rating agencies. The results also show that reporting quality is more important in reducing uncertainty when debt market participants have less access to private information. To mitigate endogeneity concerns, I use the quasi-natural experiment induced by a change in accounting standards that improved reporting quality. Implementation of the standard led to less disagreement among the rating agencies. Overall, this study contributes to the literature on the impact of reporting quality on debt markets and intermediaries.
This paper examines the stock market reaction to two different types of credit rating withdrawals by Moody’s. The first type of withdrawal occurs when a firm stops being rated. This happens, for example, when firms choose to no longer pay for a rating. We find that the stock market reaction depends on the information which remains available. The second type of withdrawal is due to Moody’s policy of removing the issuer rating and keeping the corporate family rating for the same firm. The corporate family rating is usually more favorable than the issuer rating. The paper shows that the removal of the issuer rating leads to positive stock market reaction. We conclude that lower disclosure of rating information is not necessarily associated with higher cost of equity. Instead, our findings emphasize the incentive for firms to engage in ratings shopping by publishing only the most favourable ratings.
While bankruptcy protection remains an instrument of last resort, a recent wave of petitions has aroused the interest of key participants in the municipal bond market. To date, 12 states unconditionally authorize municipalities to file for bankruptcy protection, 15 states require that municipalities satisfy certain threshold requirements, while the remaining 23 states either explicitly prohibit or have not specifically provided this authority to municipal governments. As bankruptcy protection rules influence bondholder risk exposures, we empirically test the significance of the state-specific bankruptcy eligibility requirements on borrowing costs. In a representative sample of general obligation bonds, empirical results suggest that municipalities eligible to file for bankruptcy protection pay a premium. The premium is higher if issuers are unconditionally authorized to file for bankruptcy protection, especially for debt with longer maturities. Findings also show that there are benefits associated with statutory liens; however, these benefits diminish with maturity.
This paper investigates the causes of split sovereign ratings across S&P, Moody's, and Fitch for 64 countries from 1997 to 2011. We identify that split sovereign ratings are not symmetric, with S&P tending to be the most conservative agency. We find that opaque sovereigns are more likely to receive split ratings. Political risk plays a highly significant role in explaining split ratings and dominates economic and financial indicators. Out-of-sample model performance is enhanced by capturing political risk. Government information disclosure affects split ratings between Moody's and Fitch in emerging countries. The study implies an incentive for governments to reduce political uncertainty and to enhance transparency.
This study investigates the role of tax avoidance in the credit‐rating process and whether differences exist in how rating agencies account for the risk relevance of tax avoidance. Using a sample of initial credit ratings assigned to public debt issuances during 1994–2013, our evidence is consistent with Moody's Investors Service and Standard & Poor's assessing the costs and benefits associated with tax avoidance differently from one another, resulting in more frequent and pronounced rating agency disagreement. Rating agency disagreement over tax avoidance is most evident when it is accompanied by relatively high levels of uncertain tax positions, foreign activities, research and development activities, or tax footnote opacity. We also find evidence that decreases (increases) in tax avoidance or tax footnote disclosure opacity are positively (negatively) associated with the convergence of split ratings. This suggests that firms can exacerbate or mitigate rating agency disagreement subsequent to bond issuance. Our study complements prior research by examining why sophisticated information intermediaries disagree about the risk relevance of tax avoidance. It also sheds light on how firms can influence rating agencies’ understanding of tax avoidance.
Prior research has investigated the information content of credit ratings for standard financing instruments such as stocks and corporate bonds, while this question has been neglected for convertible bonds (CBs) so far. CBs are simultaneously determined by the bond floor and the conversion value, which makes it more difficult to assess price effects following rating announcements. In this context, we compare price effects of CBs with those of stocks and corporate bonds of the same issuer using robust event study methods. Our findings indicate that rating changes convey new information for investors in European CBs. In terms of the direction of the expected price reaction, we find CBs to react in a more debt-like manner to the announcement of a rating change. Moreover, our results provide evidence that the magnitude of price reactions differs among different types of securities.
Activist shareholders have an incentive to communicate and cooperate with other major shareholders. However, the impact of their activity on information flow surrounding targeted firms is largely unknown. We explore this aspect using a prolific proponent: labor unions. Following the mailing of proxies containing union-sponsored shareholder proposals, trading volume increases significantly and at-issue bond yield spreads of targeted firms are lower compared to matched firms. Subsequent difference-in-differences analyses show that stock prices of targeted firms become more informative as a result of activism, affirming the intuition that activism results in a reduction of differential information between outside investors.
Motivated by the European debt crisis and the new European Union regulatory regime for the credit rating industry, we analyse differences of opinion in sovereign credit signals and their influence on European stock markets. Rating disagreements have a significant connection with subsequent negative credit actions by each agency. However, links among Moody’s/Fitch actions and their rating disagreements with other agencies have weakened in the post-regulation period. We also find that only S&P’s negative credit signals affect the own-country stock market and spill over to other European markets, but this is concentrated in the pre-regulation period. Stronger stock market reactions occur when S&P has already assigned a lower rating than Moody’s/Fitch prior to taking a further negative action.
We find evidence of systematic optimism and pessimism among credit analysts, comparing contemporaneous ratings of the same firm across rating agencies. These differences in perspectives carry through to debt prices and negatively predict future changes in credit spreads, consistent with mispricing. Moreover, the pricing effects are the largest among firms that are the most opaque, likely exacerbating financing constraints. We find that masters of business administration (MBAs) provide higher quality ratings. However, optimism increases and accuracy decreases with tenure covering the firm. Our analysis demonstrates the role analysts play in shaping investor expectations and its effect on corporate debt markets.
SYNOPSIS
We examine the decision relevance of a commonly suggested adjustment to how state governments report governmental pension liabilities by recalculating such pension liabilities using the return on a portfolio of high-quality municipal bonds as the discount rate. Calculated as the difference between the state's expected rate of return and the municipal bond return, we find that the discount rate adjustment associates with lower credit ratings and higher interest costs. We also find that credit rating agencies are more likely to issue conflicting ratings when the calculation of the discount rate adjustment involves greater uncertainty. Overall, while financial statement users agree about the need for and the direction of a pension liability rate adjustment, there is less consensus about the proper magnitude of this adjustment, suggesting that current accounting treatment of pensions in the public sector leads to costly uncertainty among financial statement users.
We find evidence indicating that donors use third party rating information when they donate to U.S. nonprofit organizations (nonprofits). Specifically, using a sample of over 3,800 unique nonprofits rated by the three largest charity rating organizations in 2007, and over 12,000 unrated control nonprofits, we find that rated nonprofits have significantly higher direct donations than unrated charities. We also hypothesize and find that nonprofits with ratings from multiple rating organizations receive incrementally higher levels of donations. Additionally, although charities that receive a positive rating have higher levels of donor support than those receiving a negative rating, both positively and negatively rated nonprofits receive a higher level of direct donations than unrated nonprofits. Finally, we find that nonprofits with consistently good ratings receive higher donations than those with mixed or consistently negative ratings, indicating the donor community values consistency across the three rating agencies.This article is protected by copyright. All rights reserved.
We examine the relation between asset opaqueness and split ratings. We find that firms with asset opaqueness problems are more likely to receive split bond ratings from Moody s and S&P rating agencies. Our results suggest that there is a causal link between asset opaqueness and split ratings.
Investors and regulators have been increasing their reliance on the opinions of the credit rating agencies. This article shows that although the ratings provide accurate rank-orderings of default risk, the meaning of specific letter grades varies over time and across agencies. Noting that current regulations do not explicitly adjust for agency differences, the authors argue that a reassessment of the use of ratings and the adequacy of public oversight is overdue.
A split bond rating occurs when Moody's and Standard & Poors give different ratings to the same issue. We examine 1,277 public industrial bond issues, where 221 have split ratings, issued from 1980 through mid-1993. For split-rated industrial bonds, neither rating agency consistently gives higher ratings. Earlier studies find yields for split-rated bonds to be priced as either the higher or the lower of the ratings. We find the yields on split-rated bonds to be an average of the yields on the two ratings. Split ratings for industrial bonds appear to reflect random differences on the part of rating agencies. Our results differ from previous studies because we use a substantially larger sample and include high-yield bonds. As long as a bond has an investment-grade rating, the underwriter fees are found to be essentially the same for all categories. Below investment-grade, the rating substantially affects the underwriter fee. Thus split ratings for high-yield bonds have an important effect upon the underwriter spread paid.
This paper studies optimal incentive contracts when workers have career concerns--concerns about the effects of current performance on future compensation. The authors show that the optimal compensation contract optimizes total incentives: the combination of the implicit incentives from career concerns and the explicit incentives from the compensation contract. Thus, the explicit incentives from the optimal compensation contract should be strongest for workers close to retirement because career concerns are weakest for these workers. The authors find empirical support for this prediction in the relation between chief-executive compensation and stock-market performance. Copyright 1992 by University of Chicago Press.
This paper introduces a parametrically parsimonious model for yield curves that has the ability to represent the shapes generally associated with yield curves: monotonic, humped, and S-shaped. The authors find that the model explains 96 percent of the variation in bill yields across maturities during the period 1981-83. The movement of the parameters through time reflects and confirms a change in Federal Reserve monetary policy in late 1982. The ability of the fitted curves to predict the price of the long-term Treasury bond with a correlation of 0.96 suggests that the model captures important attributes of the yield/maturity relation. Copyright 1987 by the University of Chicago.
This article presents convenient reduced-form models of the valuation of contingent claims subject to default risk, focusing
on applications to the term structure of interest rates for corporate or sovereign bonds. Examples include the valuation of
a credit-spread option.
The pattern of disagreement between bond raters suggests that banks and insurance firms are inherently more opaque than other types of firms. Moody's and S&P split more often over these financial intermediaries, and the splits are more lopsided, as theory here predicts. Uncertainty over the banks stems from certain assets, loans and trading assets in particular, the risks of which are hard to observe or easy to change. Banks' high leverage, which invites agency problems, compounds the uncertainty over their assets. These findings bear on both the existence and reform of hank regulation. (JEL G20, G21, G28).
We examine the relation between analyst forecast characteristics and the cost of debt financing. Consistent with the view that the information contained in analysts’ forecasts is economically significant across asset classes, we find that analyst activity reduces bond yield spreads. We also find that the economic impact of analysts is most pronounced when uncertainty about firm value is highest (i.e., those with high idiosyncratic risk). Our results are robust to controls for the amount of private information in equity prices and the level of corporate disclosures. Overall, our the results indicate that the information contained in analyst forecasts is valued outside the equity market and provide an additional channel in which better information is associated with a lower cost of capital.
The observed relationship between the standard deviation of forecasts and past forecast errors as found in the Livingston survey suggests the interpretation of the standard deviation as a measure of inflation uncertainty. The mean and the standard deviation for the inflation rate forecast found in the Livingston survey, furthermore, are used as regressors in a reduced-form interest rate equation. The results indicate a large negative effect of such uncertainty on interest rates. The inclusion of the uncertainty measure and commonly omitted lagged values of all variables in our analysis of data leads to more theoretically plausible estimated effects of money growth and expected inflation on interest rates than do standard estimates.
This paper examines the relationships between split ratings and ratings migration. We find that bonds with split ratings are more likely to have future rating changes. A one-notch (more-than-one-notch) split rating increases the probability of rating change within one year of initial issuance by about 3% (6%). Furthermore, we find that about 30% of split rated bonds have their two ratings converge after four years of initial issuance. The rating convergence tapers off after three years, and the rating agency with a higher (lower) initial rating generally maintains a higher (lower) rating in subsequent years if the two ratings do not converge. We also show that rating transition estimation can be improved by taking into consideration split ratings. We find that one-year rating transition matrices are significantly different between non-letter-split rated bonds and letter-split rated bonds, and we show that the difference has an economically significant impact on the pricing of credit spread options and VaR-based risk management models. Overall, our results suggest that split ratings contain important information about subsequent rating changes.
This paper addresses the estimation of default probabilities and associated confidence sets with special focus on rare events. Research on rating transition data has documented a tendency for recently downgraded issuers to be at an increased risk of experiencing further downgrades compared to issuers that have held the same rating for a longer period of time. To capture this non-Markov effect we introduce a continuous-time hidden Markov chain model in which downgrades firms enter into a hidden, ‘excited’ state. Using data from Moody’s we estimate the parameters of the model, and conclude that both default probabilities and confidence sets are strongly influenced by the introduction of hidden excited states.
This paper examines the behavior of corporate bond prices during the period surrounding the announcement of a rating change. We find some evidence of price change during the period from 18 to 7 months before the rating change is announced. We find no evidence of any reaction during the 6 months prior to the rating change. We also find little reaction, if any, during the month of the change or for 6 months after the change. This evidence contradicts the recent findings of Katz and Grier and Katz.
Several studies have documented that violations of the absolute priority rule are commonplace, and that the lowest-priority claimants benefit from violations. This study investigates the efficiency of the market for bonds of firms that default and subsequently file for Chapter 11. While the results suggest that bonds are overpriced at the time of default, the results are generally supportive of efficiency. The authors also document the losses bankrupt firms' bondholders experience over the entire life of the bond. They find that bonds with seniority provisions receive significantly higher payoffs at emergence than subordinated bonds, providing indirect evidence that the bonds are efficiently priced at issuance.
While convertible bond models recently have come to rest on solid theoretical foundation, issues in model calibration and numerical implementation still remain. This paper highlights and quantifies a number of such issues, demonstrating, among other things, that naïve calibration approaches can lead to highly significant pricing biases. We suggest a number of techniques to resolve such biases. In particular, we demonstrate how applications of the Fokker-Planck PDE allows for efficient joint calibration to debt and option markets, and also discuss volatility smile effects and the derivation of forward PDEs to embed such information into model calibration. Throughout, we rely on modern finite difference techniques, rather than the binomial or trinomial trees that so far have dominated much of the literature.
This paper provides evidence that firms with high disclosure quality ratings from financial analysts enjoy a lower effective interest cost of issuing debt. This finding is consistent with the argument that a policy of timely and detailed disclosures reduces lenders' and underwriters' perception of default risk for the disclosing firm, reducing its cost of debt. The results also indicate that the relative importance of disclosures is greater in situations where there is greater market uncertainty about the firm as reflected by the variance of stock returns. Since debt financing is an important source of external financing for publicly traded firms, the results have important implications on our understanding of the motives and consequences of corporate disclosures.
This paper uses pre-offer market valuations to evaluate the misvaluation and Q theories of takeovers. Bidder and target valuations (price-to-book, or price-to-residual-income-model-value) are related to means of payment, mode of acquisition, premia, target hostility, offer success, and bidder and target announcement-period returns. The evidence is broadly consistent with both hypotheses. The evidence for the Q hypothesis is stronger in the pre-1990 period than in the 1990–2000 period, whereas the evidence for the misvaluation hypothesis is stronger in the 1990–2000 period than in the pre-1990 period.
By examining how executive compensation structure determines corporate acquisition decisions, we document a strong positive relation between acquiring managers’ equity-based compensation (EBC) and stock price performance around and following acquisition announcements. This relation is highly robust when we control for acquisition mode (mergers), means of payment, managerial ownership, and previous option grants. Compared to low EBC managers, high EBC managers pay lower acquisition premiums, acquire targets with higher growth opportunities, and make acquisitions engendering larger increases in firm risk. EBC significantly explains postacquisition stock price performance even after controlling for acquisition mode, means of payment, and “glamour” versus “value” acquirers.
We document that purchasing (selling short) stocks with the most (least) favorable consensus recommendations, in conjunction with daily portfolio rebalancing and a timely response to recommendation changes, yield annual abnormal gross returns greater than four percent. Less frequent portfolio rebalancing or a delay in reacting to recommendation changes diminishes these returns; however, they remain significant for the least favorably rated stocks. We also show that high trading levels are required to capture the excess returns generated by the strategies analyzed, entailing substantial transactions costs and leading to abnormal net returns for these strategies that are not reliably greater than zero.
This paper investigates how the investment horizon of a firm's institutional shareholders impacts the market for corporate control. We find that target firms with short-term shareholders are more likely to receive an acquisition bid but get lower premiums. This effect is robust and economically significant: Targets whose shareholders hold their stocks for less four months, one standard deviation away from the average holding period of 15 months, exhibit a lower premium by 3%. In addition, we find that bidder firms with short-term shareholders experience significantly worse abnormal returns around the merger announcement, as well as higher long-run underperformance. These findings suggest that firms held by short-term investors have a weaker bargaining position in acquisitions. Weaker monitoring from short-term shareholders could allow managers to proceed with value-reducing acquisitions or to bargain for personal benefits (e.g., job security, empire building) at the expense of shareholder returns.
Theory predicts that the quality of a firm's information disclosure can affect the term structure of its corporate bond yield spreads. Using cross-sectional regression and Nelson-Siegel yield curve estimation, I find that firms with higher Association for Investment Management and Research disclosure rankings tend to have lower credit spreads. Moreover, this transparency spread is especially large among short-term bonds. These findings are consistent with the theory of discretionary disclosure as well as the incomplete accounting information model of Duffie and Lando (Econometrica 69 (2001) 633). The presence of a sizable short-term transparency spread can attenuate some of the empirical problems associated with structural credit risk models.
The new BIS 1998 capital requirements for market risks allows banks to use internal models to assess regulatory capital related to both general market risk and credit risk for their trading book. This paper reviews the current proposed industry sponsored Credit Value-at-Risk methodologies. First, the credit migration approach, as proposed by JP Morgan with CreditMetrics, is based on the probability of moving from one credit quality to another, including default, within a given time horizon. Second, the option pricing, or structural approach, as initiated by KMV and which is based on the asset value model originally proposed by Merton (Merton, R., 1974. Journal of Finance 28, 449–470). In this model the default process is endogenous, and relates to the capital structure of the firm. Default occurs when the value of the firm’s assets falls below some critical level. Third, the actuarial approach as proposed by Credit Suisse Financial Products (CSFP) with CreditRisk+ and which only focuses on default. Default for individual bonds or loans is assumed to follow an exogenous Poisson process. Finally, McKinsey proposes CreditPortfolioView which is a discrete time multi-period model where default probabilities are conditional on the macro-variables like unemployment, the level of interest rates, the growth rate in the economy, … which to a large extent drive the credit cycle in the economy.
We consider the estimation of credit rating transitions based on continuous-time observations. Through simple examples and using a large data set from Standard and Poor's, we illustrate the difference between estimators based on discrete-time cohort methods and estimators based on continuous observations. We apply semi-parametric regression techniques to test for two types of non-Markov effects in rating transitions: Duration dependence and dependence on previous rating. We find significant non-Markov effects, especially for the downgrade movements.
We employ a certainty-equivalence framework to analyze the cost, value and pay/performance sensitivity of non-tradable options held by undiversified, risk-averse executives. We derive “executive value” lines, the risk-adjusted analogues to Black–Scholes lines. We show that distinguishing between “executive value” and “company cost” provides insight into many issues regarding stock option practice including: executive views about Black–Scholes values; tradeoffs between options, restricted stock and cash; exercise price policies; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.
This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can predict the profitability of analysts’ recommendations. We document that the percentage of buys decreased steadily starting in mid-2000, likely due, at least partly, to the implementation of NASD Rule 2711, requiring the public dissemination of ratings distributions. Additionally, we find that a broker's ratings distribution can predict recommendation profitability. Upgrades to buy (downgrades to hold or sell) issued by brokers with the smallest percentage of buy recommendations significantly outperformed (underperformed) those of brokers with the greatest percentage of buys.
We investigate the pricing of convertible bonds on the French convertible bond market using daily market prices for a period of 18 months. Instead of a firm-value model as used in previous studies, we use a stock-based binomial-tree model with exogenous credit risk that accounts for all important convertible bond specifications and is therefore well suited for pricing convertible bonds. The empirical analysis shows that the theoretical values for the analyzed convertible bonds are on average more than 3% higher than the observed market prices. This result applies to both the standard convertibles and the exchangeable bonds in our sample. The difference between market and model prices is greater for out-of-the-money convertibles than for at- or in-the-money convertibles. A partition of the sample according to maturity indicates that there is a positive relationship between underpricing and maturity with decreasing mispricing for bonds with shorter time to maturity.
This paper assesses biases in credit ratings and lead–lag relationships for near-to-default issuers with multiple ratings by Moody’s and S&P. Based on defaults from 1997 to 2004, we find evidence that Moody’s seems to adjust its ratings to increasing default risk in a timelier manner than S&P. Second, credit ratings by the two US-based agencies are not subject to any home preference. Third, given a downgrade (upgrade) by the first rating agency, subsequent downgrades (upgrades) by the second rating agency are of greater magnitude in the short term. Fourth, harsher rating changes by one agency are followed by harsher rating changes in the same direction by the second agency. Fifth, rating changes by the second rating agency are significantly more likely after downgrades than after upgrades by the first rating agency. Additionally, we find evidence for serial correlation in rating changes up to 90 days subsequent to the rating change of interest after controlling for rating changes by the second rating agency.
We analyze the empirical power and specification of test statistics in event studies designed to detect long-run (one- to five-year) abnormal stock returns. We document that test statistics based on abnormal returns calculated using a reference portfolio, such as a market index, are misspecified (empirical rejection rates exceed theoretical rejection rates) and identify three reasons for this misspecification. We correct for the three identified sources of misspecification by matching sample firms to control firms of similar sizes and book-to-market ratios. This control firm approach yields well-specified test statistics in virtually all sampling situations considered.
A company’s credit default swap spread is the cost per annum for protection against a default by the company. In this paper we analyze data on credit default swap spreads collected by a credit derivatives broker. We first examine the relationship between credit default spreads and bond yields and reach conclusions on the benchmark risk-free rate used by participants in the credit derivatives market. We then carry out a series of tests to explore the extent to which credit rating announcements by Moody’s are anticipated by participants in the credit default swap market.
The evidence in this paper suggests that downgrades by both Moody's and Standard and Poor's are associated with negative abnormal stock returns in the two-day window beginning the day of the press release by the rating agency. Significant negative abnormal performance can still be detected after eliminating observations containing obvious concurrent (potentially contaminating) news releases. There is little evidence of abnormal performance on announcement of an upgrade. Significant abnormal returns are associated with announcements of additions to the Standard and Poor's Credit Watch List, if either a potential downgrade or a potential upgrade is indicated.
This paper analyzes the response of stock and credit default swap (CDS) markets to rating announcements made by the three major rating agencies during the period 2000–2002. Applying event study methodology, we examine whether and how strongly these markets respond to rating announcements in terms of abnormal returns and adjusted CDS spread changes. First, we find that both markets not only anticipate rating downgrades, but also reviews for downgrade by all three agencies. Second, a combined analysis of different rating events within and across agencies reveals that reviews for downgrade by Standard & Poor’s and Moody’s exhibit the largest impact on both markets. Third, the magnitude of abnormal performance in both markets is influenced by the level of the old rating, previous rating events and, only in the CDS market, by the pre-event average rating level of all agencies.
This paper investigates the hypothesis that CEOs in their final years of office manage discretionary investment expenditures to improve short-term earnings performance. We examine the behavior of R & D expenditures for a sample of firms in industries that have significant ongoing R & D activities. The results suggest that CEOs spend less on R & D during their final years in office. However, we find the reductions in R & D expenditures are mitigated through CEO stock ownership. There is no evidence that the reduced R & D expenditures are associated with either poor firm performance or reductions in investment expenditures that are capitalized for accounting purposes.
Assistant Professor of Finance, New York University. The author acknowledges the helpful suggestions and comments of Keith V. Smith, Edward F. Renshaw, Lawrence S. Ritter and the Journal' reviewer. The research was conducted while under a Regents Fellowship at the University of California, Los Angeles.
Eleven percent of the largest public U.S. firms are headed by the CEO who founded the firm. Founder-CEO firms differ systematically from successor-CEO firms with respect to firm valuation, investment behavior, and stock market performance. Founder-CEO firms invest more in research and development, have higher capital expenditures, and make more focused mergers and acquisitions. An equal-weighted investment strategy that had invested in founder-CEO firms from 1993 to 2002 would have earned a benchmark-adjusted return of 8.3% annually. The excess return is robust; after controlling for a wide variety of firm characteristics, CEO characteristics, and industry affiliation, the abnormal return is still 4.4% annually. The implications of the investment behavior and stock market performance of founder-CEO firms are discussed.
L'int�r�t de l'approche par les jeux globaux ("global games'') est pr�cis�ment d'ancrer les anticipations sur des variables exog�nes r�elles. On peut ainsi garder l'aspect auto-r�alisateur des anticipations mais en restaurant l'unicit� de l'�quilibre et donc un meilleur pouvoir pr�dictif du mod�le. Nous illustrons ces m�canismes sur deux exemples. Le premier a trait au choix r�sidentiel d'agents qui ont une pr�f�rence "identitaire''. Le second a trait � la contagion de paniques bancaires d'un pays � un autre. De mani�re plus g�n�rale, tous les jeux qui pr�sentent des compl�mentarit�s strat�giques sont susceptibles d'�tre analys�s au moyen des techniques des "global games''. Il convient toutefois de rappeler que les techniques utilis�es demeurent assez sp�cifiques: l'incertitude strat�gique porte essentiellement sur les croyances de premier degr� des autres acteurs. Or, si de mani�re plus g�n�rale on suppose que cette incertitude peut porter sur des ordres plus �lev�s, les conclusions des mod�les peuvent changer. Ainsi, Weinstein et Yildiz (2004) montrent que dans un oligopole de Cournot, il y a une tr�s grande multiplicit� d'�quilibres si on suppose que l'incertitude porte sur les croyances de niveaux suffisamment �lev�s.
I examine the introduction of syndicated bank loan ratings by Moody's and Standard & Poor's in 1995 to evaluate whether third-party rating agencies affect firm financial and investment policy. The introduction of bank loan ratings leads to an increase in the use of debt by firms that obtain a rating, and also increases in firms' asset growth, cash acquisitions, and investment in working capital. Consistent with a causal effect of the ratings, the increase in debt usage and investment is concentrated in the set of borrowers who are of lower credit quality and do not have an issuer credit rating before 1995. A loan-level analysis demonstrates that previously unrated borrowers who obtain a loan rating gain increased access to the capital of less-informed investors. The results suggest that third-party debt certification has real effects on firm investment policy. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.
This article studies how collateral affects bond yields. Using a large data set of public bonds, we document that collateralized debt has higher yield than general debt, after controlling for credit rating. Our model of agency problems between managers and claim holders explains this puzzling result by recognizing imperfections in the rating process. We test the model's implications. Consistent with our model and in results new to the literature, we find the yield differential between secured and unsecured debt, after controlling for credit rating, is larger for low credit rating, nonmortgage assets, longer maturity, and with proxies for lower levels of monitoring.
The articles in this symposium cover some of the most active areas of research in macroeconomics. By design, each article is structured to present both a theoretical framework and empirical evidence. Through this structure, the articles synthesize recent developments, present new results, and provide guidance on avenues for further research. Earlier versions of these papers were presented at the Economic Fluctuations research meeting of the National Bureau of Economic Research on October 22 and 23, 1993. All papers were subject to the peer referee process that is standard at the 'Review of Economics and Statistics.' The 'Review' gratefully acknowledges the efforts of Professor Russell Cooper of Boston University and Professor Steven Durlauf of the University of Wisconsin (Madison), who volunteered their services to work as special co-editors for this symposium, with the assistance of the chair of the board of editors of the 'Review,' James Stock. Copyright 1996 by MIT Press.
This paper investigates whether and how individual managers affect corporate behavior and performance. We construct a manager-firm matched panel data set which enables us to track the top managers across different firms over time. We find that manager fixed effects matter for a wide range of corporate decisions. A significant extent of the heterogeneity in investment, financial, and organizational practices of firms can be explained by the presence of manager fixed effects. We identify specific patterns in managerial decision-making that appear to indicate general differences in "style" across managers. Moreover, we show that management style is significantly related to manager fixed effects in performance and that managers with higher performance fixed effects receive higher compensation and are more likely to be found in better governed firms. In a final step, we tie back these findings to observable managerial characteristics. We find that executives from earlier birth cohorts appear on average to be more conservative; on the other hand, managers who hold an MBA degree seem to follow on average more aggressive strategies. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
The stock market has opinions as to what choices firms should make. We show that concern for current share prices may lead managers to make these choices rather than those suggested by their own superior information. Even when arbitrarily many privately informed firms have to make a similar decision, the market's "prejudices" may still prevail. We compare the distortions that arise from share-price maximization with those due to herd behavior among profit-maximizing firms, and show that the former results in strictly less efficient use of information.
Executives can only impact firm outcomes if they have influence over crucial decisions. On the basis of this idea, we develop
and test the hypothesis that firms whose CEOs have more decision-making power should experience more variability in performance.
Focusing primarily on the power the CEO has over the board and other top executives as a consequence of his formal position
and titles, status as a founder, and status as the board’s sole insider, we find that stock returns are more variable for
firms run by powerful CEOs. Our findings suggest that the interaction between executive characteristics and organizational
variables has important consequences for firm performance.
Research in behavioral corporate finance takes two distinct approaches. The first emphasizes that investors are less than fully rational. It views managerial financing and investment decisions as rational responses to securities market mispricing. The second approach emphasizes that managers are less than fully rational. It studies the effect of nonstandard preferences and judgmental biases on managerial decisions. This survey reviews the theory, empirical challenges, and current evidence pertaining to each approach. Overall, the behavioral approaches help to explain a number of important financing and investment patterns. The survey closes with a list of open questions.
The purpose of this article is to explain the spread between spot rates on corporate and government bonds. We find that the spread can be explained in terms of three elements: (1) compensation for expected default of corporate bonds (2) compensation for state taxes since holders of corporate bonds pay state taxes while holders of government bonds do not, and (3) compensation for the additional systematic risk in corporate bond returns relative to government bond returns. The systematic nature of corporate bond return is shown by relating that part of the spread which is not due to expected default or taxes to a set of variables which have been shown to effect risk premiums in stock markets Empirical estimates of the size of each of these three components are provided in the paper. We stress the tax effects because it has been ignored in all previous studies of corporate bonds.
We study the default behavior of original issue high-yield bonds to answer the open question of how the probability of default changes over time. We use a flexible econometric method, the Cox proportional hazard, to model the default behavior of junk bonds over their life. The method allows us to include the impact of issue and issuer characteristics on the probability of and the time to default in the estimation. Using a large comprehensive sample, we find that the bonds face a constantly increasing default risk over time, with the most significant increase beyond four years after issuance.
This review examines the incentives of managers to use investment choices as a tool for building their personal reputations or the reputation of their firms. These incentives come in three main forms: visibility bias, which encourages a manager to try to make short-term indicators of success look better; resolution reference which encourages a manager to try to advance the arrival of good news and delay bad news; and mimicry and avoidence, which encourages a manager to take the actions that the best managers are seen to do, and to avoid the actions the worst managers are seen to do.