The Mitigating Effect of Bank Financing on Shareholder Value and Firm Policies Following Rating Downgrades

Abstract

We investigate whether a firm's debt structure can act as a mitigating factor to the negative effects of a corporate rating downgrade. Specifically, we study how a firm's relative mix of bank and non-bank financing affects its stock market valuation and leverage adjustment following a downgrade. We document that, in the high-yield segment, companies with a larger proportion of bank debt suffer less from the distorting effects of rating downgrades, as they: (i) experience less negative abnormal stock returns around the event; (ii) reduce their market leverage less than peers that rely more on other sources of debt. Our findings confirm the benefits of bank financing for risky firms and provide a number of new insights into how debt structure affects firm value and capital structure decisions over and above the information directly embedded in credit ratings.