Market Responses to Credit Rating Changes Given Prior Performance and the Association with Information Asymmetry and Corporate Governance

Abstract

Credit ratings are important for real estate investment trusts (REITs) given their dependence on external capital to support growth. However, relatively little research has examined how credit rating changes can impact shareholder wealth. We document new evidence showing how the market response to REIT credit rating changes is associated with prior return performance. We demonstrate that previous results indicating a negative reaction to REIT credit rating downgrades are associated with prior periods of positive performance. We report new evidence showing an insignificant reaction to downgrades for credit rating changes after periods of negative performance. We also report new findings indicating a positive market reaction to upgrades following periods of negative performance. These findings suggest the market anticipates bad news after negative performance and good news after periods of positive performance. We find higher information asymmetry (less transparency) is associated with stronger market reactions to credit rating changes. Moreover, stronger corporate governance is associated with increased transparency as reflected in milder abnormal returns to credit rating changes.