Would Managers use Financial Disclosures to Influence Credit Ratings?

Author: Dr. Guanming He Durham University Business School, United Kingdom Credit ratings are widely used for valuation, contracting, a...

Author: Dr. Guanming He

Durham University Business School, United Kingdom

Credit ratings are widely used for valuation, contracting, and regulatory compliance for a firm (Kisgen, 2006). So, managers have an incentive to maintain or achieve a desired credit rating by influencing credit rating agencies’ perceptions about corporate creditworthiness (He, 2018a, b). Whether they tend to influence rating agencies’ decisions in a credible or opportunistic manner is an important issue, given that the quality of credit rating has been a big concern for widespread practitioners in the financial marketplace.

In a paper published at the Global Journal of Management and Business Research (He, 2018a), I investigate whether managers use management earnings forecasts, a typical form of voluntary financial disclosure, to influence credit ratings. I address this issue by looking at whether managers alter their management earnings forecasts strategies during an impending rating change to manage rating agencies’ perceptions of corporate credit risk. Whether managers would do so depends crucially on their perceptions about the likelihood and extent that the management earnings forecasts would be discerned by outsiders as opportunistic or credible, and hence is an open question to explore.

Using a large sample of U.S. listed firms, I find that firms near a credit rating change do not opportunistically alter their earnings forecast practices to manipulate credit ratings. Specifically, firms close to a credit rating change do not selectively release good news or withhold bad news on their earnings information; nor do the firms likely issue an optimistically biased forecast or a more precise forecast for good news than for bad news. 

Credit rating is maintained regularly with a firm for long and widely used by outsiders for valuation, investment, regulatory, and contractual purposes. Not only rating agencies but also other outside stakeholders oversee a firm’s rating information all along. As such, credit rating constitutes a repeated game between managers and outside stakeholders (He, 2018a). Managers might deceive outsiders of interest in the short term by pursuing opportunistic financial disclosures, but would be penalized for the cheating once the opportunism is detected (He, 2018a).These explain why there is no evidence in my study to suggest that credit ratings are manipulated by managers via their earnings forecasts. This result implies managers’ concern that credit rating issuers/users are likely able to undo the strategic behaviors.

Ideas for future works

Given managers’ desire for a higher credit rating, it is important to examine the ex ante actions managers may take to prevent a credit rating downgrade or achieve a rating upgrade in the settings when their firms’ credit ratings are close to changes. An extension of this research, with an aim to shed more light on managers’ incentives to maintain or achieve a desired credit rating, is to look at managers’ financial reporting and disclosures right after their firms experience credit rating changes. Given negative consequences of credit rating downgrades (e.g., Ederington and Goh, 1998; Dichev and Piotroski; 2001; Almeida, et al., 2017), it will be interesting to examine whether, and to what extent, managers would manipulate financial reporting and disclosures in a temperate manner after credit rating downgrades. Managing financial numbers upwards, albeit unlikely to recoup a previous credit rating that had been downgraded, would at least mitigate the adverse economic impact of the credit rating downgrade for the firm. Thus, I would expect a relatively high likelihood and degree of managers’ manipulation of financial numbers (earnings, among others) right after credit rating downgrades.

References

Almeida, H., Cunha, I., Ferreira, M.A., and Restrepo, F., 2017. The real effects of credit ratings: The sovereign ceiling channel.Journal of Finance 72, 249-290.
Dichev, I., and Piotroski, J.D., 2001. The long-term stock returns following bond ratings changes. Journal of Finance 56, 173-204.
Ederington, L.H., and Jeremy, C.G., 1998. Bond rating agency and stock analysts: who knows what when? Journal of Financial and Quantitative Analysis 33, 569-585.
He, G., 2018a. The impact of impending credit rating changes on management earnings forecasts. Global Journal of Management and Business Research, 18 (4), 1-18.
He, G., 2018b. Credit ratings and managerial voluntary disclosures. Financial Review, 53 (2),            337-378.
Kisgen, D.J., 2006. Credit ratings and capital structure. Journal of Finance 61 (3), 1035-1072.

This post comes from Dr. Guanming He, who is an associate professor at the Durham University Business School. It is based on his recent article, “The impact of impending credit rating changes on management earnings forecasts” available here.

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Global Journals | Business Innovations & Stories Blog: Would Managers use Financial Disclosures to Influence Credit Ratings?
Would Managers use Financial Disclosures to Influence Credit Ratings?
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