Abstract
This paper documents two stylized facts related to firms' credit ratings and their capital structure decisions. First, firms' dependence on debt financing is positively related to their credit ratings. Firms with higher credit ratings issue more debt and less equity than firms with lower credit ratings. Second, the effects of potential credit rating changes on firms' capital structure decisions are asymmetric. When they face potential rating downgrades, firms issue more debt and have an increased reliance on debt issuance as their external finance. In contrast, when firms face potential rating upgrades, there is no significant change in their choice of external finance. Lastly, in an attempt to provide a theoretical interpretation of the empirical results, the paper also proposes a last call model, which predicts a pooling equilibrium among firms that face potential rating downgrades and a separating equilibrium among firms face potential rating upgrades.
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