The Influence of Credit Ratings on Corporate Capital Structure Decisions

Many academics and market analysts have argued that corporate managements pay too much attention to maintaining high credit ratings. But if some companies place too much emphasis on ratings, the benefits of higher ratings discussed in this article suggest that many firms may be justified in sticking with lower levels of leverage to secure such ratings. Besides expanding a company's pool of eligible investors and increasing liquidity, higher ratings can also provide a number of other potentially value-increasing benefits, including the financial flexibility provided by access to commercial paper markets and more favorable terms from non-investor corporate stakeholders- particularly customers and suppliers-that are reassured by the firm's implied staying power. Consistent with these arguments, the author reports the findings of his own studies showing that companies nearing a credit rating upgrade or downgrade tend to issue less debt (relative to equity) than other comparable firms. And companies that are downgraded are more likely to reduce leverage to regain their old rating. Such behavior is also most pronounced in companies on the verge of becoming investment-grade, or at risk of falling below it-and in firms whose ratings changes are likely to affect their access to commercial paper.