Does increased creditworthiness lead to a reduced interest rate? : a study of external credit ratings' potential to influence a company's average interest rate

Abstract

The main objective is to explain whether increased creditworthiness leads to decreased average interest rates. The creditworthiness is represented by Bisnode’s credit rating codes. Involved in the study are Norwegian limited liability companies. The assessment extends from 2005 to 2011, and the analyses were executed for each year separately. The motivation has been to verify if creditors are covering credit risk responsibly by requiring an amount of compensation, in the form of an interest rate, which is at par with the perceived level of company credit risk. The credit rating codes are divided into five categories and regression analysis has been applied in order to detect whether the differences between the interest rate per credit rating code are statistically and economically significant. Almost all interest rate differences between the credit rating codes are found statistically significant. The findings do not apply to the interest rate difference between AAA- and AA-rated companies or between AA- and A-rated companies, due to insignificant results. The order of the differences is as expected. C-rated companies carry higher interest rates than B-rated companies, which carry higher interest rates than A-rated companies, etc. The economic significance is considered high due to the large size of the interest rate differences and because credit rating code changes are detected frequently. This proves that firms extending credit rating codes contribute to enable well-functioning credit markets between debtor and creditor on the capital market. One of the limitations of this thesis has been the aggregated level of the interest rates. When executing further research, it would be advantageous to access less aggregated data and also to increase the sample size. In to obtain more accurate average interest rate calculations, the interest rates should be weighed according to the size of the relevant firm’s interest-bearing debt.nhhma