Information Asymmetry and Firms' Credit Market Access: Evidence from Moody's Credit Rating Format Refinement

Abstract

I exploit Moody's 1982 credit rating refinement to examine the impact of more refined rating information on firms' credit market access, financing decisions, and investment policies. First, I decompose the information content of the rating refinement into predictable and unpredictable components. While firms' ex ante cost of borrowing can partially predict the direction of refinement changes, firms with rating refinement upgrades as a result of additional rating gradations still experience a significant decrease in their ex post cost of borrowing compared to firms with rating refinement downgrades. The former subsequently also issue more debt and rely more on debt financing over equity than the latter. These effects remain both economically and statistically significant even when controlling for the heterogeneity in firms' ex ante cost of borrowing. Lastly, rating refinement is associated with more capital investments, less cash accumulation, and faster asset growth for the upgraded firms than the downgraded firms. These findings suggest that third-party rating agencies help to reduce credit market information asymmetry through disclosure of new information and thereby significantly affect firms' credit market access as well as their real outcomes.