Does Credit Rating Provide Incremental Predictive Power on a Firm’s Future Financial Distress? Evidence from China

Lina Yan, Yao Hu, Minghuan Li and Kam C. Chan

Emerging Markets Finance and Trade, 2023, vol. 59, issue 12, 3798-3812

Abstract: We examine the incremental predictive power of credit rating on a firm’s future financial distress using a sample of Chinese credit ratings from 2008 to 2019. Our findings suggest that such credit ratings, especially those using investor-pay mode, improve the incremental predictive power of firms’ future financial distress. Specifically, a one notch rating level increase of issuer-pay (investor-pay) credit rating translates into 1.69% (10.24%) lower probability of financial distress. The findings are robust to using a propensity score matching sample and an alternative metric for financial distress. Additional analysis suggests that the incremental predictive power of credit rating on financial distress is more salient for subsamples of credit ratings 1) issued by credit rating agencies (CRAs) with large market shares, 2) when a CRA has a low likelihood of collusion with a firm, or 3) when a firm receives both investor-pay and issuer-pay credit rating.

Date: 2023
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DOI: 10.1080/1540496X.2023.2226325

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