Credit Ratings and Short-term Debt Financing: An Empirical Analysis of Listed Firms in Korea

Abstract

This paper investigates how credit ratings affect trade credit use in short-term debt financing. According to the empirical results, under information asymmetry in the debt market, credit ratings play a key role both as a screening device for the lender and as a signaling device for the borrower. That is, the credit rating system can mitigate the problem of information asymmetry to improve efficiency in the allocation of funds in Korea's short-term debt market. Noteworthy is that, according to the empirical results, there is a nonlinear relationship between the level of credit ratings and trade credit use. Among firms with low-ratings, an increase in credit ratings reduces trade credit use in Korea, whereas among those with high ratings, an increase in credit ratings increases trade credit use. Given that large firms have high credit ratings in Korea, the positive relationship between the level of credit ratings and trade credit use suggests the possibility of predatory trade credit transactions. In addition, various characteristics of borrowing firms, such as size, financial distress, product characteristics, and industry characteristics, are key determinants of trade credit use in short-term debt financing.