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Initial credit ratings and earnings management
Author(s) -
Demirtas K. Ozgur,
Rodgers Cornaggia Kimberly
Publication year - 2013
Publication title -
review of financial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.347
H-Index - 41
eISSN - 1873-5924
pISSN - 1058-3300
DOI - 10.1016/j.rfe.2013.05.003
Subject(s) - credit rating , accrual , earnings management , bond credit rating , issuer , business , equity (law) , debt , endogeneity , earnings , credit risk , accounting , actuarial science , economics , credit reference , econometrics , finance , political science , law
Credit rating agencies assert that they rely on financial information provided by issuers and that they value rating stability as well as accuracy. In an environment where rating agencies depend on issuer‐reported information and are reluctant to adjust ratings promptly, managers of issuing firms can utilize the discretion afforded by GAAP to obtain the most favorable credit ratings. Consistent with our expectations, we find that current accruals are unusually positive and high around initial credit ratings. The increase in abnormally high accruals leading up to the initial credit rating year is followed by a reversal in the subsequent years. Multivariate regression analyses suggest that accounting accruals, abnormal current accruals in particular, are significantly positively related to initial credit ratings after controlling for several issue‐ and issuer‐related characteristics indicative of default risk. Our results are robust to additional tests that account for endogeneity between credit ratings and earnings management, adjust for performance, and account for firms issuing debt and equity simultaneously.