The Real Effects of Credit Ratings: Evidence from Corporate Asset Sales

Abstract

What is the relative contribution of credit rating downgrades on financial distress and managerial discipline? We find that firms are more likely to conduct asset sales following a credit rating downgrade, particularly so if firms indicate the purpose is to use the proceeds to pay down outstanding debt or to raise cash. We find a smaller or no effect if the sale is motivated by concentrating on core assets or involves the sale of a loss making or bankrupt operation. Shareholder wealth effects of the asset sale following a credit rating downgrade are consistent with the event being perceived by the market as a successful mechanism by the seller to mitigate financial distress caused by the downgrade and where buyers benefit from discounted fire-sale prices and when the assets have greater asset redeployability. Asset sales following a downgrade are more likely to involve segments that are the most liquid, generate the least current cash flows, and have the highest growth opportunities. Peer-based performance, intrafirm performance, or relatedness to core activities, do not explain the choice for which segments are divested. Our results suggest that firms respond to credit rating downgrades with asset sales in an attempt to reduce financial distress and that downgrades, at the margin, exacerbate financial distress rather than induce managerial discipline.