Abstract
We find partial support for the Credit Rating-Capital Structure hypothesis: firms make a larger effort to avoid a potential credit rating downgrade; but not to achieve an upgrade. Credit ratings provide information to investors, and therefore changes in credit ratings affect markets. Financial markets punish firms which have a downgrade in credit ratings via covenant restrictions. Firms near a potential credit downgrade make larger capital structure changes in capital structure decisions. However, the extent of the effect of credit ratings to capital structure choice may vary across the types of companies. This article examines to what extent credit ratings affect the choice of capital structure in business segments. The paper identifies the magnitude of capital structure changes vary for financial firms and for utility companies, is greater for non-investment (i.e. speculative) grade firms due to a certification effect, and the magnitude varies over both time and across the credit spectrum, and is related to credit spreads.
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