What do credit rating agencies tell us about earnings momentum?

This study extends the literature on the effects of earnings momentum on credit ratings in debt markets by investigating the wider dimensions of their economic implications. Consistent with prior research, our research provides empirical evidence of an association between earnings momentum and credit ratings and further explores whether business fundamentals determine earnings momentum. We find that credit rating agencies assign higher (lower) credit ratings for firms with increasing (decreasing) earnings momentum and that the credit rating implications of decreasing earnings momentum are more pronounced. We further find that increasing (decreasing) earnings momentum with high (but not low) accounting quality can predict better (worse) future firm performance. Our findings suggest that traditional measures of low reporting quality indicate information with respect to future prospects. Our empirical evidence seems to support the view that earnings momentum is a manifestation of a firm's true performance as perceived by credit rating agencies.