Do Firms Manage Their Credit Ratings? Evidence from Rating-Based Contracts

SYNOPSIS: This paper examines whether firms with rating-based performance-priced loan contracts (PPrating firms) manage cash flow from operations (CFO) and accruals to obtain better firm credit ratings. I find that for PPrating firms, both CFO management and accruals management, are positively associated with firm credit ratings. In the cross-section, the relation of CFO management and accruals management with firm ratings is less pronounced when there is a larger benefit associated with inflated firm ratings. These results support the view that financial statement manipulation helps PPrating firms achieve more favorable ratings; when these firms are subject to more stringent rating-agency monitoring, such manipulation proves less effective.