IDEAS home Printed from https://ideas.repec.org/a/bla/jbfnac/v49y2022i5-6p1011-1073.html
   My bibliography  Save this article

Credit rating downgrade risk and acquisition decisions

Author

Listed:
  • Mengyao Kang

Abstract

This study examines the impact of credit rating downgrade risk on acquisition decisions. I find that firms at risk of a rating downgrade conduct fewer acquisitions. This result is robust to different measures of downgrade risk, instrumental variable analyses and matched sample tests. The correlation between downgrade risk and acquisition propensity is likely driven by the concern that risks associated with acquisitions lead to downgrades as evidenced by the more cautious approach of acquirers facing downgrade risk. These firms take more time to complete deals, hire more and higher‐quality financial advisors, issue less debt to finance merger consideration, adopt target termination fee clauses and select targets with lower information asymmetry and higher ratings. This more cautious approach is associated with better long‐term post‐merger performance and reduced future‐downgrade risk. Subgroup analyses reveal credit rating downgrade risk is negatively associated with acquisition decisions and positively associated with performance for investment‐grade firms, especially BBB‐ firms, which are on the brink of being downgraded to non‐investment grade. Such associations are not significant for non–investment‐grade firms. Overall, the results suggest that firms at risk of a rating downgrade conduct acquisitions more cautiously, leading to fewer but more value‐creating deals.

Suggested Citation

  • Mengyao Kang, 2022. "Credit rating downgrade risk and acquisition decisions," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 49(5-6), pages 1011-1073, May.
    • Handle: RePEc:bla:jbfnac:v:49:y:2022:i:5-6:p:1011-1073
    DOI: 10.1111/jbfa.12571
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/jbfa.12571
    Download Restriction: no
    File URL: https://libkey.io/10.1111/jbfa.12571?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Mara Faccio & Ronald W. Masulis, 2005. "The Choice of Payment Method in European Mergers and Acquisitions," Journal of Finance, American Finance Association, vol. 60(3), pages 1345-1388, June.
    2. M.J. Barron & A.D. Clare & S.H. Thomas, 1997. "The Effect of Bond Rating Changes and New Ratings on UK Stock Returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(3), pages 497-509.
    3. Campello, Murillo & Graham, John R. & Harvey, Campbell R., 2010. "The real effects of financial constraints: Evidence from a financial crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 470-487, September.
    4. Dirk Jenter & Katharina Lewellen, 2015. "CEO Preferences and Acquisitions," Journal of Finance, American Finance Association, vol. 70(6), pages 2813-2852, December.
    5. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. "The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-752, June.
    6. David A. Ziebart & Sara A. Reiter, 1992. "Bond ratings, bond yields and financial information," Contemporary Accounting Research, John Wiley & Sons, vol. 9(1), pages 252-282, September.
    7. Sara B. Moeller & Frederik P. Schlingemann & René M. Stulz, 2007. "How Do Diversity of Opinion and Information Asymmetry Affect Acquirer Returns?," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2047-2078, November.
    8. Hainmueller, Jens, 2012. "Entropy Balancing for Causal Effects: A Multivariate Reweighting Method to Produce Balanced Samples in Observational Studies," Political Analysis, Cambridge University Press, vol. 20(1), pages 25-46, January.
    9. Jory, Surendranath R. & Ngo, Thanh N. & Wang, Daphne, 2016. "Credit ratings and the premiums paid in mergers and acquisitions," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 93-104.
    10. Louis H. Ederington & Jess B. Yawitz & Brian E. Roberts, 1987. "The Informational Content Of Bond Ratings," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 10(3), pages 211-226, September.
    11. Darren J. Kisgen & Philip E. Strahan, 2010. "Do Regulations Based on Credit Ratings Affect a Firm's Cost of Capital?," The Review of Financial Studies, Society for Financial Studies, vol. 23(12), pages 4324-4347, December.
    12. Dongmei Li, 2011. "Financial Constraints, R&D Investment, and Stock Returns," The Review of Financial Studies, Society for Financial Studies, vol. 24(9), pages 2974-3007.
    13. Karampatsas, Nikolaos & Petmezas, Dimitris & Travlos, Nickolaos G., 2014. "Credit ratings and the choice of payment method in mergers and acquisitions," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 474-493.
    14. James W. Wansley & Terrence M. Clauretie, 1985. "The Impact Of Creditwatch Placement On Equity Returns And Bond Prices," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 8(1), pages 31-42, March.
    15. Harford, Jarrad & Klasa, Sandy & Walcott, Nathan, 2009. "Do firms have leverage targets? Evidence from acquisitions," Journal of Financial Economics, Elsevier, vol. 93(1), pages 1-14, July.
    16. Eugene F. Fama, 2002. "Testing Trade-Off and Pecking Order Predictions About Dividends and Debt," The Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 1-33, March.
    17. Yim, Soojin, 2013. "The acquisitiveness of youth: CEO age and acquisition behavior," Journal of Financial Economics, Elsevier, vol. 108(1), pages 250-273.
    18. Andrey Golubov & Dimitris Petmezas & Nickolaos G. Travlos, 2012. "When It Pays to Pay Your Investment Banker: New Evidence on the Role of Financial Advisors in M&As," Journal of Finance, American Finance Association, vol. 67(1), pages 271-312, February.
    19. Pilar Abad‐Romero & M. Dolores Robles‐Fernandez, 2006. "Risk and Return Around Bond Rating Changes: New Evidence From the Spanish Stock Market," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(5‐6), pages 885-908, June.
    20. Audra L. Boone & J. Harold Mulherin, 2009. "Is There One Best Way to Sell a Company? Auctions Versus Negotiations and Controlled Sales1," Journal of Applied Corporate Finance, Morgan Stanley, vol. 21(3), pages 28-37, June.
    21. Holthausen, Robert W. & Leftwich, Richard W., 1986. "The effect of bond rating changes on common stock prices," Journal of Financial Economics, Elsevier, vol. 17(1), pages 57-89, September.
    22. Kisgen, Darren J., 2009. "Do Firms Target Credit Ratings or Leverage Levels?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(6), pages 1323-1344, December.
    23. Peter Cheng & Lin Li & Wilson H.S. Tong, 2016. "Target Information Asymmetry and Acquisition Price," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 43(7-8), pages 976-1016, July.
    24. Frijns, Bart & Gilbert, Aaron & Lehnert, Thorsten & Tourani-Rad, Alireza, 2013. "Uncertainty avoidance, risk tolerance and corporate takeover decisions," Journal of Banking & Finance, Elsevier, vol. 37(7), pages 2457-2471.
    25. Ai, Chunrong & Norton, Edward C., 2003. "Interaction terms in logit and probit models," Economics Letters, Elsevier, vol. 80(1), pages 123-129, July.
    26. Harford, Jarrad & Uysal, Vahap B., 2014. "Bond market access and investment," Journal of Financial Economics, Elsevier, vol. 112(2), pages 147-163.
    27. West, Richard R, 1973. "Bond Ratings, Bond Yields and Financial Regulation: Some Findings," Journal of Law and Economics, University of Chicago Press, vol. 16(1), pages 159-168, April.
    28. Chen, Xia & Harford, Jarrad & Li, Kai, 2007. "Monitoring: Which institutions matter?," Journal of Financial Economics, Elsevier, vol. 86(2), pages 279-305, November.
    29. Ederington, Louis H. & Goh, Jeremy C., 1998. "Bond Rating Agencies and Stock Analysts: Who Knows What When?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 33(4), pages 569-585, December.
    30. Aktas, Nihat & Petmezas, Dimitris & Servaes, Henri & Karampatsas, Nikolaos, 2021. "Credit ratings and acquisitions," Journal of Corporate Finance, Elsevier, vol. 69(C).
    31. Offenberg, David, 2009. "Firm size and the effectiveness of the market for corporate control," Journal of Corporate Finance, Elsevier, vol. 15(1), pages 66-79, February.
    32. David Hillier & Patrick McColgan & Athanasios Tsekeris, 2020. "Value creation around merger waves: The role of managerial compensation," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(1-2), pages 132-162, January.
    33. Wang, Ashley W. & Zhang, Gaiyan, 2009. "Institutional ownership and credit spreads: An information asymmetry perspective," Journal of Empirical Finance, Elsevier, vol. 16(4), pages 597-612, September.
    34. Dimitrios Gounopoulos & Hang Pham, 2017. "Credit Ratings and Earnings Management around IPOs," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 44(1-2), pages 154-195, January.
    35. Cai, Ye & Sevilir, Merih, 2012. "Board connections and M&A transactions," Journal of Financial Economics, Elsevier, vol. 103(2), pages 327-349.
    36. Liu, Pu & Thakor, Anjan V, 1984. "Interest Yields, Credit Ratings, and Economic Characteristics of State Bonds: An Empirical Analysis: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(3), pages 344-351, August.
    37. Allen N. Berger & Seth D. Bonime & Lawrence G. Goldberg & Lawrence J. White, 2004. "The Dynamics of Market Entry: The Effects of Mergers and Acquisitions on Entry in the Banking Industry," The Journal of Business, University of Chicago Press, vol. 77(4), pages 797-834, October.
    38. Tang, Tony T., 2009. "Information asymmetry and firms' credit market access: Evidence from Moody's credit rating format refinement," Journal of Financial Economics, Elsevier, vol. 93(2), pages 325-351, August.
    39. Jack Bao & Alex Edmans, 2011. "Do Investment Banks Matter for M&A Returns?," The Review of Financial Studies, Society for Financial Studies, vol. 24(7), pages 2286-2315.
    40. Uysal, Vahap B., 2011. "Deviation from the target capital structure and acquisition choices," Journal of Financial Economics, Elsevier, vol. 102(3), pages 602-620.
    41. Charles J. Hadlock & Joshua R. Pierce, 2010. "New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index," The Review of Financial Studies, Society for Financial Studies, vol. 23(5), pages 1909-1940.
    42. Masulis, Ronald W. & Simsir, Serif Aziz, 2018. "Deal Initiation in Mergers and Acquisitions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 53(6), pages 2389-2430, December.
    43. M.J. Barron & A.D. Clare & S.H. Thomas, 1997. "The Effect of Bond Rating Changes and New Ratings on UK Stock Returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(3), pages 497-509, April.
    44. Moeller, Sara B. & Schlingemann, Frederik P. & Stulz, Rene M., 2004. "Firm size and the gains from acquisitions," Journal of Financial Economics, Elsevier, vol. 73(2), pages 201-228, August.
    45. Lu, Chia-Wu & Chen, Tsung-Kang & Liao, Hsien-Hsing, 2010. "Information uncertainty, information asymmetry and corporate bond yield spreads," Journal of Banking & Finance, Elsevier, vol. 34(9), pages 2265-2279, September.
    46. Cantor, Richard & Packer, Frank, 1997. "Differences of opinion and selection bias in the credit rating industry," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1395-1417, October.
    47. Harford, Jarrad & Humphery-Jenner, Mark & Powell, Ronan, 2012. "The sources of value destruction in acquisitions by entrenched managers," Journal of Financial Economics, Elsevier, vol. 106(2), pages 247-261.
    48. Ronald W. Masulis & Cong Wang & Fei Xie, 2007. "Corporate Governance and Acquirer Returns," Journal of Finance, American Finance Association, vol. 62(4), pages 1851-1889, August.
    49. Darren J. Kisgen, 2006. "Credit Ratings and Capital Structure," Journal of Finance, American Finance Association, vol. 61(3), pages 1035-1072, June.
    50. Humphery-Jenner, Mark L. & Powell, Ronan G., 2011. "Firm size, takeover profitability, and the effectiveness of the market for corporate control: Does the absence of anti-takeover provisions make a difference?," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 418-437, June.
    51. Jeffrey Harrison & Matthew Hart & Derek Oler, 2014. "Leverage and acquisition performance," Review of Quantitative Finance and Accounting, Springer, vol. 43(3), pages 571-603, October.
    52. Steven N. Kaplan & Luigi Zingales, 1997. "Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(1), pages 169-215.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Karampatsas, Nikolaos & Petmezas, Dimitris & Travlos, Nickolaos G., 2014. "Credit ratings and the choice of payment method in mergers and acquisitions," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 474-493.
    2. Ting-Kai Chou, 2013. "Information content of credit ratings in pricing of future earnings," Review of Quantitative Finance and Accounting, Springer, vol. 40(2), pages 217-250, February.
    3. Panagiotis K. Staikouras, 2012. "A Theoretical and Empirical Review of the EU Regulation on Credit Rating Agencies: In Search of Truth, Not Scapegoats," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 21(2), pages 71-155, May.
    4. Renneboog, Luc & Vansteenkiste, Cara, 2019. "Failure and success in mergers and acquisitions," Journal of Corporate Finance, Elsevier, vol. 58(C), pages 650-699.
    5. Aktas, Nihat & Petmezas, Dimitris & Servaes, Henri & Karampatsas, Nikolaos, 2021. "Credit ratings and acquisitions," Journal of Corporate Finance, Elsevier, vol. 69(C).
    6. Alexandridis, George & Chen, Zhong & Zeng, Yeqin, 2021. "Financial hedging and corporate investment," Journal of Corporate Finance, Elsevier, vol. 67(C).
    7. Kaveri Krishnan & Sankarshan Basu & Ashok Thampy, 2020. "Has the Global Financial Crisis Changed the Market Response to Credit Ratings? Evidence from an Emerging Market," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 19(1), pages 7-32, April.
    8. Field, Laura Casares & Mkrtchyan, Anahit & Wang, Yuan, 2022. "Bond liquidity and investment," Journal of Banking & Finance, Elsevier, vol. 145(C).
    9. Hasan, Iftekhar & Huang, He & To, Thomas Y., 2021. "Are credit rating disagreements priced in the M&A market?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 72(C).
    10. Kim, Seonhyeon & Thompson, Ephraim Kwashie & Kim, Changki, 2023. "Credit rating and managerial behavior in investment decision making: Evidence from the Korean market," Journal of Behavioral and Experimental Finance, Elsevier, vol. 37(C).
    11. Sean Cleary & Ashrafee Hossain, 2020. "POSTCRISIS M&As AND THE IMPACT OF FINANCIAL CONSTRAINTS," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 43(2), pages 407-454, May.
    12. Field, Laura Casares & Mkrtchyan, Anahit, 2017. "The effect of director experience on acquisition performance," Journal of Financial Economics, Elsevier, vol. 123(3), pages 488-511.
    13. Guo, Jie (Michael) & Li, Yichen & Wang, Changyun & Xing, Xiaofei, 2020. "The role of investment bankers in M&As: New evidence on Acquirers’ financial conditions," Journal of Banking & Finance, Elsevier, vol. 119(C).
    14. Thomas Lagner & Dodozu Knyphausen‐Aufseß, 2012. "Rating Agencies as Gatekeepers to the Capital Market: Practical Implications of 40 Years of Research," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 21(3), pages 157-202, August.
    15. Feng, Yun & Liu, Chelsea & Yawson, Alfred, 2023. "Economic shocks, M&A advisors, and industry takeover activity," Pacific-Basin Finance Journal, Elsevier, vol. 82(C).
    16. Shoaib Ali & Attiya Yasmin Javid, 2015. "Relationship between Credit Rating, Capital Structure and Earning Management Behaviour: Evidence from Pakistani Listed Firms," PIDE-Working Papers 2015:121, Pakistan Institute of Development Economics.
    17. Huang, Qianqian & Jiang, Feng & Wu, Szu-Yin (Jennifer), 2018. "Does short-maturity debt discipline managers? Evidence from cash-rich firms' acquisition decisions," Journal of Corporate Finance, Elsevier, vol. 53(C), pages 133-154.
    18. Yuriy Zabolotnyuk, 2018. "Wealth Effects of Bond Rating Announcements," Multinational Finance Journal, Multinational Finance Journal, vol. 22(3-4), pages 211-254, September.
    19. Alexandridis, George & Antypas, Nikolaos & Gulnur, Arman & Visvikis, Ilias, 2020. "Corporate financial leverage and M&As choices: Evidence from the shipping industry," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 133(C).
    20. Harford, Jarrad & Humphery-Jenner, Mark & Powell, Ronan, 2012. "The sources of value destruction in acquisitions by entrenched managers," Journal of Financial Economics, Elsevier, vol. 106(2), pages 247-261.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jbfnac:v:49:y:2022:i:5-6:p:1011-1073. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.blackwellpublishing.com/journal.asp?ref=0306-686X .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.