Is Indebtedness Always Negative for Credit Ratings? Empirical Evidence on Newly Rated Firms

Abstract

Firms care deeply about their credit ratings, since ratings influence, for instance, firms’ cost of capital, bond and stock market prices. This is also true for newly rated firms, typically smaller, in a younger stage of their life cycle and with a shorter track record compared with other issuers. In this paper, I intend to test the impact of being a newly rated firm on credit ratings over the period 1985 to 2013. I report a negative but rather low effect on rating outcome for the entire sample of newly rated firms but, I find a strong positive relation between highly levered firms and credit rating. This result is in sharp contrast with the effect of debt on ratings outcome, which is strongly negative. My findings suggest that rating agencies tend to cater to issuer’s insider needs when they are mainly exposed to the debt market and could generate a new stream of revenues for rating agencies.