The Information Content of Commercial Paper Rating Downgrades: Further Evidence

Abstract

In this paper, we study the association between commercial paper rating downgrades and expectations of the level and variability of future earnings. Our examination shows that such rating downgrades are associated with a significant reduction in analyst forecasts of near-term earnings. We document a tendency by financial analysts at the Value Line Investment Survey to progressively revise their estimates of quarterly earnings downward on average and implement two methods to control for the resulting bias. The reduction in earnings estimates is robust to these controls. In addition, we observe an increase in systematic risk for a subset of firms for which the downgrade implies exit from the commercial paper market. Analysis of stock price changes around the downgrade announcement dates shows that although the information on lower future earnings reflected in mild rating downgrades merely confirms market beliefs, the information on lower level and/or higher variability of future earnings associated with severe downgrades constitutes new information unavailable to the market prior to the rating change announcement.