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Review of Quantitative Finance and Accounting

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18-09-2017 | Original Research

Is less information better information? Evidence from the credit rating withdrawal

Author: Federica Salvadè

Published in: Review of Quantitative Finance and Accounting | Issue 1/2018

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Abstract

This paper examines the stock market reaction to two different types of credit rating withdrawals by Moody’s. The first type of withdrawal occurs when a firm stops being rated. This happens, for example, when firms choose to no longer pay for a rating. We find that the stock market reaction depends on the information which remains available. The second type of withdrawal is due to Moody’s policy of removing the issuer rating and keeping the corporate family rating for the same firm. The corporate family rating is usually more favorable than the issuer rating. The paper shows that the removal of the issuer rating leads to positive stock market reaction. We conclude that lower disclosure of rating information is not necessarily associated with higher cost of equity. Instead, our findings emphasize the incentive for firms to engage in ratings shopping by publishing only the most favourable ratings.

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Close references to this analysis are Kliger and Sarig (2000) and Liu et al. (1999) which analyze a change in policy by Moody’s which by refining the rating scale had the effect of increasing the precision of the rating. Similar to our study, the previously-noted authors show that although those changes in ratings were not triggered by changes in firms’ fundamentals, they influenced the market price.

Some examples are: Gropp and Richards (2001), Griffin and Sanvicente (1982), Clauretie and Wansley (1985), Holthausen and Leftwich (1986), Cornell et al. (1989), Hand et al. (1992), Ederington and Goh (1993, 1999, 1998), Dichev and Piotroski (2001), Elayan et al. (2003), Norden and Weber (2004), Jorion et al. (2005), Li et al. (2006), Jorion and Zhang (2007), Kim and Nabar (2007), Choy et al. (2006) and Purda (2007).

Policy for withdrawal of credit rating 2011, Moody’s Investor Services.

Moody’s Investor Service, 2011a, b. Moody's rating symbols and definition.

The policy change removes the issuer rating the day of the policy’s implementation only if the firm has no debt outstanding. Since we investigate the reaction the day of the implementation, we are not able to analyze the contemporaneous effect of the withdrawal on the bond price.

Results do not change when we estimate a market model based on a pan-European index.

Non parametric tests are not reported for brevity. Results do not change and are available upon request.

We map Standard & Poor’s and Moody’s credit ratings on a numerical 28 rating scale (AAA/Aaa = 28,…, D/C = 6), similar to (Becker and Milbourn 2011).

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Title: Is less information better information? Evidence from the credit rating withdrawal
Author: Federica Salvadè
Publication date: 18-09-2017
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 1/2018
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-017-0666-5

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