13 research outputs found
Collateral Requirements of SMEs: The Evidence from Less–Developed Countries
A rating trigger is a particular type of debt covenant that mandates the borrower to
maintain its own credit rating above a certain rating threshold, requiring in the
event of a rating downgrade the adoption of specific enforceable actions aimed at
securing the lender claims from the borrower's higher risk level. Rating triggers
lower the cost of borrowing capital, but in case they are activated they exacerbate
the borrower's need for liquidity just in the moment when its credit risk is higher,
making the borrower's default more likely to occur. Despite the potential threat
posed by rating triggers on debt markets, these contractual devices remain almost
unregulated both in the U.S. and in Europe. The purpose of this paper is first to
analyze the effects rating triggers can have on overall market risk and second to
assess the proliferation of rating triggers among large U.S. companies in order to
ensure whether these contractual devices need a stricter regulation. The article is
divided in two parts. From section 2 to 5, I provide an overview on the different
types of triggers and analyze the rationale behind their use in terms of advantages
and disadvantages for both issuers and investors. From section 6 to 9 I perform an
empirical analysis by assessing the rating triggers that have been used by Dow
Jones Industrial Average index companies. I then examine the correlation between
the use of rating triggers and the companies’ risk profiles by measuring their
credit ratings and their Altman’s Z-Scores in order to find out whether triggers are
mostly used by risky companies, capable of being impaired by the triggers’
activation and thus posing a threat to market stability. Then in section 10 I draw
the conclusions suggesting the introduction by U.S. and European regulators of a
specific duty to disclose all the rating triggers that listed companies include every
year in bond indentures and in financial contract