Corporate risk-taking after changes in credit rating

Abstract

PurposeThe paper aims to investigate corporate risk-taking following changes in firms' credit ratings (CR) and the mechanisms the firms use in implementing the risk-taking.Design/methodology/approachThe paper employs fixed-effect regression models to examine risk-taking behaviour after firms experience changes in CR after their ratings are downgraded to the lower edge of the investment grade rating (i.e. BBB-) and after their CRs are downgraded below the investment rating.FindingsThe paper finds that, whilst in general, changes in CR are negatively associated with post-event risk-taking, firms downgraded to BBB- do not increase their risk-taking. Only when firms are rated below this grade, firms significantly increase their risk-taking, suggesting that the association between downgrades in CR and firm risk-taking following the event is not linear. Further analysis suggests that these downgraded firms do not increase research and development (R&D) expenses or capital expenditures but employ long-term debt as their risk-taking mechanism.Practical implicationsThe findings of the paper have practical implications for investors considering investing in downgraded-rating firms to shareholders of such firms and especially to those overseeing the firms' risk-taking policies.Originality/valueThe study fills the gap in the literature by providing empirical evidence on corporate risk-taking after changes in CR and also contributes to the optimal debt-maturity choice literature.