The question about capital structure is one of the most important issues which the management of a company faces in implementing their daily business. Therefore, the question of which factors affect capital structure decisions attracts high attention in the past and recent literature on capital structure. There are many papers providing valuable insights into capital structure choices, starting with the paper of Modigliani and Miller (1958). The MM-Theorem is generally considered a purely theoretical result since it ignores important factors in the capital structure decision like bank-ruptcy costs, taxes, agency costs and information asymmetry. Based on this paper many other theories which consider factors neglected by Modigliani and Miller have been evolved. Two major theories are the Tradeoff- and the Pecking-Order-Theory. The former loosens assumptions stated in the MM-Theorem by including bankruptcy costs and taxes while the latter introduces information asymmetry into the capital structure discussion. Chapter 2.1 will give a brief overview of these theories. For complexity reasons these models cannot capture all relevant factors affecting the capital structure policy of a company. However, all these theories disregard one cru-cial factor which plays an important role on capital markets all over the world. The significance of Credit Ratings is gradually increasing, and it is doing so in many re-spects. This paper focuses on the Credit Rating-Capital Structure-Hypotheses (CRCS) developed by Darren J. Kisgen as a modern approach to the capital structure discussion. The hypothesis argues that credit ratings have an impact on capital struc-ture decisions due to discrete costs (benefits) associated with a rating change. Firstly, reasons why credit ratings are material for capital structure decisions will be out-lined. Then, situations in which credit rating effects play a role will be examined. For this issue it is very important to show how it can be measured whether a firm is con-cerned about a rating change or not. Afterwards the CR-CS will be empirically tested. The traditional theories don’t explain the results obtained in these tests. Therefore credit rating effects will be combined with factors discussed in the Tradeoff- and Pecking-Order-Theory. In subsequent empirical tests credit rating factors will be integrated into previous capital structure test to show that the results of the CR-CS tests remain statistically significant...
Table of Contents
1. Introduction
2. Credit Ratings in the Context of Traditional Capital Structure Theories
2.1 The Tradeoff and Pecking-Order Theory
2.2 Credit Ratings
2.3 The Credit Rating-Capital Structure-Hypothesis
3. Testing the Impact of Credit Ratings on Capital Structur Decisions
3.1 Specification of the Test
3.2 Data and Summary Statistics
3.3 Empirical Tests of the CR-CS
4. Incorporating the CR-CS in the existing Capital Structure Theory
4.1 Credit Rating Effects vs. Tradeoff and Percking-Order Theory
4.2 Nesting Credit Rating Effects into Tradeoff and Pecking-Order Tests
5. Complementing the Credit Rating-Capital Structure-Hypothesis
5.1 Capital Structure Decisions after a Rating Change
5.2 Testing the ex post Behavior
6. Conclusion
Objectives and Topics
This seminar paper examines the "Credit Rating-Capital Structure-Hypothesis" (CR-CS) developed by Darren J. Kisgen, which posits that credit ratings significantly influence corporate capital structure decisions due to discrete costs and benefits associated with rating changes. The paper evaluates whether firms manage their leverage specifically to avoid downgrades or achieve upgrades, thereby challenging traditional models like the Tradeoff- and Pecking-Order-Theories.
- The role of credit ratings as an overlooked factor in capital structure policy.
- Theoretical mechanisms linking rating changes to corporate financing behavior.
- Empirical testing of how firms adjust net debt relative to equity near rating thresholds.
- Integration of credit rating effects into existing trade-off and pecking-order frameworks.
- Analysis of ex-post capital structure adjustments following actual rating changes.
Excerpt from the Book
2.3 The Credit Rating-Capital Structure-Hypothesis
Kisgen’s CR-CS links chapter 2.1 and chapter 2.2, claiming that credit ratings are a material consideration in managers’ capital structure decisions due to the discrete costs (benefits) associated with different rating levels. In addition, the hypothesis argues that concerns about the impact of credit rating changes directly affect capital structure decision making, with firms close a ratings change issuing less net debt relative to net equity than firms not close a ratings change. This statement has to be proven by both economic facts and empirical tests. Hence, before conducting empirical tests, reasons are outlined supporting the hypothesis that there is a relation between credit ratings and capital structure. A simple but quite intuitive fact is that a utility-maximizing manager will consider credit ratings since higher ratings are associated with higher reputation. It is therefore likely that credit ratings affect capital structure policy.
Summary of Chapters
1. Introduction: Presents the research question regarding the impact of credit ratings on capital structure and outlines the paper's focus on the CR-CS hypothesis.
2. Credit Ratings in the Context of Traditional Capital Structure Theories: Reviews the Tradeoff- and Pecking-Order theories and introduces the relevance of credit ratings as an additional factor.
3. Testing the Impact of Credit Ratings on Capital Structur Decisions: Describes the empirical framework, dummy variables, and "Credit Score" method used to test the CR-CS hypothesis.
4. Incorporating the CR-CS in the existing Capital Structure Theory: Combines credit rating effects with traditional theories to show that the CR-CS remains statistically significant in broader contexts.
5. Complementing the Credit Rating-Capital Structure-Hypothesis: Analyzes ex-post capital structure behavior to see if firms adjust leverage after rating changes in line with ex-ante theories.
6. Conclusion: Summarizes the findings, confirming that credit ratings are a material factor that must be integrated into a comprehensive model of capital structure.
Keywords
Credit Rating, Capital Structure, Tradeoff Theory, Pecking-Order Theory, Leverage, Net Debt, Equity, Financial Distress, Credit Rating Agencies, Corporate Finance, Information Asymmetry, Rating Change, Credit Score, Debt Offering, Equity Offering.
Frequently Asked Questions
What is the core focus of this research paper?
The paper focuses on the Credit Rating-Capital Structure-Hypothesis (CR-CS), which suggests that credit ratings directly impact how companies make decisions about their capital structure.
Which specific theories does the author build upon?
The author discusses the traditional Tradeoff- and Pecking-Order-Theories and attempts to complement them by integrating credit rating considerations.
What is the primary goal of the study?
The goal is to demonstrate that firms near a rating change adjust their financing (issuing less debt) to either avoid a downgrade or improve their chances of an upgrade.
How is the empirical research conducted?
The research uses regressions and dummy variables based on Standard & Poor's data to test the significance of credit rating proximity on capital structure decisions.
What topics are covered in the main body?
The main body covers the theoretical basis of the hypothesis, empirical testing using "Plus and Minus" and "Credit Score" tests, and an integration into existing capital structure models.
Which keywords best describe this work?
Key terms include Credit Rating, Capital Structure, Leverage, Tradeoff Theory, and Pecking-Order Theory.
What role do "Credit Scores" play in the empirical analysis?
Credit Scores are used to identify firms that are close to a "Micro Rating" change, allowing the researcher to test if firms within these categories exhibit specific capital structure behaviors.
How does a firm's downgrade affect its capital structure?
The empirical findings suggest that firms tend to reduce their leverage following a downgrade in order to regain their previous credit rating level.
- Quote paper
- Christian Kronwald (Author), 2009, Credit Rating and the Impact on Capital Structure, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/146614
