Credit rating and bank behavior in India: Possible implications of the new Basel accord

The paper examines the impact of credit rating on capital adequacy ratios of Indian state-owned banks using quarterly data for the period 1997:1 to 2002:4. To this end, a multinomial logit model with multi credit rating indicators as dependent variable is estimated. The variables that can impinge upon capital adequacy ratio have been used as explanatory variables. Two separate models — one for long-term credit rating and another for short-term credit rating—have been estimated. The paper concludes that, both for short-term as well as for long-term ratings, capital adequacy ratios are an important factor impinging on credit rating of Indian state-owned banks.banknig; capital adequacy; credit rating; multinomial logit model; India

Does conditional conservatism affect credit ratings? An analysis of Korean KRX bond issuers

We examine whether there is a relationship between conditional conservatism and credit ratings. Credit rating levels are the ‘opinion‘ of credit rating agencies about a firm’s default risk based on financial statements data and corporate governance information. In South Korea, credit rating levels are issued by National Information & Credit Evaluation (NICE), Korea Investor Services (KIS), Korea Ratings (KR) and Seoul Credit Rating & Information (SCI), and are used by bond investors, debt issuers, and governmental officials for decision making and legislative purposes. Accounting practices such as conditional conservatism have the potential to signal low default risk and financial stability. Accounting conservatism reflects a manager’s tendency to recognize “bad news” in a timelier manner than “good news” (Basu, 1997). The academic community continues to debate the merits of conservatism. However, the majority of studies suggest that conditional conservatism is an accounting practice with the potential to increase accounting quality (Watts, 2003; Roychowdhury and Watts, 2007; Ball and Kothari, 2008). In the U. S., numerous studies find an association between level of conservatism and credit ratings (Ahmed et al., 2002; Moerman (2006); Nikolaev (2007); Bauwhede (2007): Zhang, 2008; Peek 2010). Therefore, in the U.S., there is evidence to suggest that credit ratings agencies care about conditional conservatism as an accounting practice with the potential to influence default risk. In South Korea, there is evidence of a positive relation between accounting conservatism levels and credit ratings (Park et al., 2011). However, the association between credit rating changes and financial conservatism is a question left unanswered. Our motivation is to address this caveat. To our knowledge, our study is the first to analyze the association between conditional conservatism and credit ratings and credit rating changes using the two most popular conditional conservatism measures. We contribute to the literature by providing an evidence that conditional conservatism may influence a credit rating agency’s perception of default risk. We examine if conditional conservatism is associated with credit ratings based on the following; conditional conservatism is an accounting practice associated with reducing a manager‘s ability to 'inflate' net income; hence, constraining dividend has the potential to reduce a credit rating agency’s perception of risk. Credit rating agencies issue higher credit ratings to firms with lower default risk. Thus, because firms care deeply about maintaining or increasing their credit ratings, conservative reporting should have a positive a relation with credit rating levels / credit ratings changes. We perform numerous tests to establish the relation between conditional conservatism and credit ratings / credit rating changes. We investigate the relationship between a firm's credit ratings / credit ratings changes and conditional conservatism using a KRX firm sample of 1,310 firm-years from 2002 to 2013. First, we establish the levels of conditional conservatism using the accruals based Ball and Shivakumar (2005) and the market based Basu (1997) models. The results suggest that firms borrow equity in the form of public debt are conservative, consistent with previous studies. Next, we use a dummy variable approach to examine the relationship between conservatism and credit ratings for investment / non-investment grade firms. We find that investment and non-investment grade firms have statistically insignificantly different levels of financial conservatism. Thirdly, we test if conditional conservatism has a statistically significant relation with credit rating changes. We find that firms that experience an increase or a decrease in their credit rating levels from period t to t+1 are marginally more conservative compared to firms with consistent credit rating levels. Next, we test the relation between conditional conservatism and credit rating increases. Firms with higher levels of conservatism may benefit from a credit rating increase because an increase in conservatism indicates lower risk. We use a dummy variable approach to capture if conservatism in period t has the potential to influence a credit rating period in t+1. We do not find a statistically significant relation between conservatism and credit ratings for our entire sample. However, we find that there is a positive relation between conservatism in period t and a credit rating increase in period t+1 for investment grade firms. Credit ratings have significant implications for a firm’s access to capital. Firms below the investment grade level (BBB+ and below) are expected to face higher capital costs and face limited access to investor equity because of legislative restrictions compared to firms with investment grade bonds (A- to AAA). Credit ratings agencies may reward financially conservative firms above the investment grade threshold with a credit rating’s increase because conditional conservatism is considered an important risk metric for firms above the investment grade. Other metrics may be more critical to firms below the investment grade cut-off. Finally, we perform robustness checks for our main hypothesis. We find that firms that experience a credit rating increase in period t+1 have statistically significantly higher levels of conservatism in period t compared to firms experience a credit rating decrease or remain constant in period t+1, supporting our previous findings. Taken together, our results suggest that credit ratings agencies consider conditional conservatism when issuing credit ratings. Firms with higher credit ratings are generally more conservative. Moreover, conditionally conservative firms above the investment grade threshold can be rewarded with a credit rating increase

When AAA Means B: The State of Credit Rating in India

As in many other countries, India five year old credit rating industry has grown rapidly amidst persistent doubts about the quality of the rating service. This paper evaluates the ratings given by India leading credit rating agency, CRISIL. We find that CRISIL ratings are not only too liberal by international standards but also internally inconsistent. We argue that to improve the quality of credit rating in India, there must be more competition; credit rating must be opened up to the private sector; and raters must provide unsolicited ratings.

Have credit rating agencies become more stringent towards Japanese regional banks?

This article investigates empirically whether foreign and domestic credit rating agencies tightened their standards for evaluating Japanese regional banks from 2000 to 2009. We extend and enhance previous studies, including Gonis and Taylor (2009), by estimating an ordered probit model using pooled data for this period. Our results reveal that foreign agencies did not rate Japanese regional banks more stringently during this period, perhaps because they wished not to repel clients and reduce their revenues. Japan’s rating agencies showed the opposite tendency, perhaps to seek credibility among foreign investors.credit ratings; rating stringencies; regional banks; foreign credit rating agencies; domestic credit rating agencies

Does Financial Performance Influence Credit Ratings? An analysis of Korean KRX Firms

Credit rating agencies offer information about default risk. Previous literature suggests that firm’s credit ratings are influenced by various metrics, specifically, numerous risk considerations such as size, leverage and growth. However, there is limited evidence to support the relationship between credit ratings and financial performance. Our research is motivated by this caveat. The purpose of this paper is to discover if financial performance measures can be included as an indicator for default risk since the relation between financial performance and default risk/credit rating is a question left unanswered in a South Korean context. In this paper, we empirically test if financial performance measures can provide additional information about credit ratings and credit rating changes. We perform a battery of tests to establish if the following financial performance measures: EPS, CPS, ROA, ROE, and ROS have any explanatory power in explaining credit ratings levels and credit rating changes. Using a sample from 2002 to 2013, we find that EPS and CPS has a statistically positive relation to credit ratings, suggesting that firms with higher credit ratings have higher levels of EPS and CPS compared to firms with lower credit ratings. Moreover, we find that firms with positive performance measured by EPS and CPS in period t have the potential to experience a credit ratings change in period t+1. However, in South Korea, the majority of firms do not experience a credit ratings change. When we estimate the financial performance of the firms that do not experience a credit ratings change, we find a statistically significant relation between credit rating and financial performance for EPS and CPS. The results suggest that credit ratings for firms with positive financial performance remain stable Finally, we examine the relation between performance in period t and credit ratings increase and decrease in period t+1. The results suggest that the credit ratings of firms with high level of financial performances increase or remain the same. We do not find a relation between financial performance and credit rating decreases; this result may be due to our small sample size. The previous literature has largely ignored the association between credit ratings and performance. Taken together, our results suggests that EPS and CPS can be used as financial performance measures by investors, government agencies and debt issuers as additional information about a firms credit rating levels, and subsequent changes. We contribute to the literature by providing empirical evidence of a relationship between performance metrics and credit ratings, specifically the link between EPS

Credit Rating and Debt Crises

We develop an equilibrium theory of credit rating in the presence of rollover risk. By influencing rational creditors, ratings affect sovereigns' probability of default, which in turn affects ratings. Our analysis reveals a pro‐cyclical impact of credit rating: In equilibrium the presence of a rating agency increases default risk when it is high and decreases default risk when it is low

Measuring the impact of innovation on firm value: a new approach

Most of the existing empirical literature on the relationship of firm value and knowledge capital is based on the stock market valuation of companies. However, the assets of many firms are not publicly traded, and hence the calculation of market value is limited to a subsample of firms. We suggest to use a credit rating score instead and present an empirical analysis. It turns out that innovative firms, i.e. those with a reasonable knowledge stock, have a better credit rating and thus, as we propose, a higher value. However, too much of innovative activi-ties is seen as risky and the firm value decreases. --Firm Value,Credit Rating,Innovation,Intellectual Property Discrete Regression Models

Do firms engage in earnings management to improve credit ratings?: Evidence from KRX bond issuers

In this paper, we examine the relationship between credit ratings, credit ratings changes and earnings management. Since the 1997 Asian Financial Crisis, many listed firms collapsed, leading investors to suffer losses. As a result, credit ratings have become a very important indicators of firms’ financial stability for investors, government agencies and debt issuers and other stakeholders. Firms with a similar credit rating are grouped together as firms of similar credit quality (Kisgen 2006) because credit ratings provide an ‘economically meaningful role’ (Boot et al. 2006). Numerous studies find that managers care deeply about their credit ratings (Graham and Harvey 2001; Kisgen 2009; Hovakimian at al. 2009). Firms that borrow equity in the form of bonds may have incentives to increase credit ratings with opportunistic earnings management. A change in a firm’s credit ratings has a direct impact on a firm’s profitability. Firm’s benefit from better terms from suppliers, enjoy better investment opportunities and have lower cost of capital when their credit risk is lower. Firms incur a higher cost of debt and experience additional costs when their credit risk is higher. American studies find that firms use earnings management to influence credit ratings (Ali and Zhang 2008; Jung et al. 2013; Alissa et al 2013). Credit rating agencies have stated they assume financial statements to be reasonable and accurate (Securities and Exchange Commission, 2003; Standard and Poor’s, 2006) and they do not consider themselves to be auditors. They take the information in the financial statements as accurate. Therefore, there is a potential for managers to engage in earnings management to influence credit ratings. In South Korea, there have been numerous experiments with auditor legislation because of financial collapses due to earnings management in the 2000s. Therefore, a decomposition of the relation between opportunistic earnings management and credit ratings is an important consideration for Korean accounting academia. Previous Korean studies have examined whether credit ratings in period t are significantly related to level of earnings management in the same period; however, those studies fail to find the consistent results. It is widely known that credit rating agencies allow one year credit watch period to assess default risk before credit rating decision. Firms with an incentive to increase their credit ratings through earnings management will only realize if earnings management positively influences credit ratings in the following year. Therefore, we focus on establishing a relationship between the levels of earnings management at time t and credit ratings / changes at time t+1. Our study provides a more robust analysis by establishing if both accrual based and real earnings management in period t influences credit ratings and credit rating changes in period t+1. Using a sample of 1,717 Korean KRX firm-years from 2002 to 2013, we find a negative relation between earnings management in period t and credit ratings in period t+1, suggesting that firms with higher credit ratings have lower levels of earnings management. Moreover, we find that firms that experience a credit ratings change in period t+1 are less likely to engage in opportunistic earnings management in period t, suggesting that firms do not have the potential to increase credit ratings. We also find that firms that experience a credit rating increase in period t+1 have a negative association with opportunistic earnings management for accruals measures. Moreover, when we split our sample into firms that experience 1) a credit rating increase, 2) decrease and 3) remaining the same, we find that firms that engage in earnings management are more likely to remain unchanged or experience a credit rating decrease. Thus, taken together, we find no evidence of relationship between opportunistic earnings management and an increase in credit ratings in the South Korean public debt market. Our results may be of interest to regulators, credit rating agencies, market participants and firms that question whether level of earnings management in current year influences credit ratings in the subsequent period

Dividend smoothing and credit rating changes

This paper examines the impact of credit rating changes on firms' dividend smoothing behavior, considering for the first time the"big three" credit rating agencies (Standard and Poor's, Fitch and Moody's). Using a hand collected sample of credit rating changes for firms listed at the S&P500 that are involved in dividend payments, we implement the traditional Lintner's (1956) model and we initially verify the fact that firms smooth their dividend payments. Then we consider the effect of credit rating changes on smoothing behavior and we show the presence of an asymmetric impact on credit rating changes to dividend smoothing behavior. In particular, on average, a credit rating downgrade among any of the three credit rating agencies forces firms to engage in less smoothing, whereas a credit rating upgrade has only a marginal positive effect on dividend smoothing. Finally, our key results remain valid for firms with high level of financial pressure and under various robustness checks