Is a Bond Rating Downgrade Bad News, Good News, or No News for Stockholders?

• Main Authors: GOH, Choo Yong, Jeremy, Ederington, Louis H.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1993
• Subjects: Bond ratings; expected returns; stock prices; Business; Corporate Finance; Finance and Financial Management
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2199; https://ink.library.smu.edu.sg/context/lkcsb_research/article/3198/viewcontent/Bond_Rating_1993_pv.pdf
• Institution: Singapore Management University

We examine the reaction of common stock returns to bond rating changes. While recent studies find a significant negative stock response to downgrades, we argue that this reaction should not be expected for all downgrades because: (1) some rating changes are anticipated by market participants and (2) downgrades because of an anticipated move to transfer wealth from bondholders to stockholders should be good news for stockholders. We find that downgrades associated with deteriorating financial prospects convey new negative information to the capital market, but that downgrades due to changes in firms' leverage do not.