The Real Costs of Corporate Credit Ratings

Abstract

Credit rating agencies emphasize the importance of specific financial ratio thresholds in their rating process. Firms below these thresholds are more likely to receive higher ratings than similar firms that are not. I show that firms near key Debt/EBITDA thresholds are significantly more likely to reduce R\&D and SG\&A expenditures (boosting EBITDA) prior to bond issuance compared to observationally similar firms not near a threshold. Subsequently, they are more likely to experience declines in patent productivity, profitability, and Tobin's Q. These distortions highlight an important cost of arm's-length financing and an adverse consequence of transparency in credit rating criteria.