The Real Effects Of Credit Ratings: Evidence From Corporate Asset Sales
Dion Bongaerts, Erasmus University
Credit rating agencies (CRAs) have been accused of exacerbating financial distress through downgrades, but are also perceived as dedicated monitors when debt holdings are widely dispersed.
In this paper, we investigate the relative contribution of credit rating downgrades on financial distress and managerial discipline. We show that firms are more likely to conduct an asset sale following
a credit rating downgrade, particularly if firms indicate that the purpose is to pay down outstanding debt or raise cash. We find a smaller or no effect of downgrades on the likelihood of asset sales with
the purpose of concentrating on core assets or selling loss-making or bankrupt operations. In a placebo test we find that downgrades do not affect the likelihood of spinoffs, which do not involve a cash infusion for the firm.
Stock price reactions to asset sales following a credit rating downgrades are consistent with financial distress relief for sellers and a way for buyers to benefit from fire-sale prices. Asset sales following a downgrade
are concentrated in segments that are most liquid, generate lowest current cash flows, and have highest growth opportunities. Peer-based performance, intra-firm performance rank, or relatedness to core activities,
do not explain the choice of divested segments. Our results suggest that firms respond to credit rating downgrades with asset sales in an attempt to reduce financial distress and that downgrades, at the margin,
exacerbate financial distress rather than induce managerial discipline.