Are credit ratings forward-looking? - Evidence from India

PurposeThis paper aims to examine the informational value of credit rating changes for investors. The article analyses whether credit rating changes indicate the future financial performance of a firm.Design/methodology/approachThe study employs pooled time-series cross-section regression technique and two-sample t-test for analysis. The paper utilizes a firm's operating profit as a proxy of its future financial performance to understand what inference can be drawn about future financial performance from a change in a firm's credit rating.FindingsThe paper finds that a firm operating profit declines in the year after a credit rating downgrade. However, no such significant relationship is evident in the case of a rating upgrade. The results are consistent across rating categories and individual years of the sample period.Research limitations/implicationsThe study uses non-financial corporate rating data; hence, the findings may not apply to credit rating changes in financial corporates and structured finance.Practical implicationsInvestors and analysts can incorporate credit rating downgrade by CRAs as a key input in a firm's future financial forecast. Analysts and investment managers can also look at credit rating changes of firms in the same industry and draw a definite conclusion about which firm is likely to see a higher deterioration in performance.Originality/valueThe author has not come across any literature that directly investigates credit rating changes from the perspective of information content about future financial performance.