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Credit watch and capital structure

Kristopher J. Kemper and Ramesh Rao ()

Applied Economics Letters, 2013, vol. 20, issue 13, 1202-1205

Abstract: We study the capital structure reactions of firms that have been added to Standard & Poor's (S&P's) CreditWatch list in order to test the role of credit ratings in firm financial decisions. Survey evidence by Graham and Harvey (2001) indicates that Chief Financial Officers (CFOs) consider credit ratings as the second most important determinant of financing policy. If credit ratings are indeed important, we should observe that firms facing a potential downgrade should react by reducing debt financing in an attempt to avert the potential rating downgrade. In the case of a potential upgrade, we should also observe a scaling back of debt financing to reinforce the rating upgrade. We find evidence for the latter but for potential downgrade firms, contrary to expectations; we find that these firms issue more debt relative to equity. Overall, we conclude that while credit ratings may be a consideration in determining corporate financing policy, it is probably a secondary determinant.

Date: 2013
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DOI: 10.1080/13504851.2013.799746

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