Optimal capital structure decision with credit rating management

Abstract

This paper examines the impact of credit rating management on determining optimal capital structure. The models capture twofold empirical behavior of credit rating management: the using of rating-linked coupon scheme and target minimum rating policy. Numerical results showed that as long as the rating at issuing time is not too low, tax shields of the rating-linked coupon debt are larger than those of standard debt with same par, and hence, optimal leverage usage of the firm with rating-linked coupon scheme is greater. Further, the behavior of targeting a minimum rating causes a mean-reverting leverage dynamic. Following a downgrade from target minimum rating, managers appear to make over-repurchased choices for adjusting the current ratings back to the initial target. Key words: Optimal capital structure, credit rating, rating-linked coupon scheme, target minimum rating policy.