Are REITs more Transparent than Stock: Evidence Using a Propensity Score Model

Research on the broader US equity market shows that corporate credit rating downgrades and negative Credit Watch announcements affect stock prices negatively. Holthausen and Leftwich (1986) examine the common stock price reaction to bond rating changes and Credit Watch announcements and find evidence of a stock price response to all events except an actual rating upgrade. Dichev and Piotroski (2001) examine the long-run stock returns following bond ratings changes, using Moody’s bond rating changes from the 1970 to 1997 time period. They find limited abnormal performance for upgrades, but statistically significant negative abnormal returns of 10 to 14% in the year subsequent to a downgrade. Thus, they conclude the market does not fully anticipate the negative implications of downgrades for future profitability.REITs on the other hand may or may not react similarly to credit rating announcements due to their special regulatory environment. The literature points to credit ratings as a factor that broadly impacts external financing decisions and capital structure. REITs target debt levels to obtain credit ratings just above the investment grade cutoff point where clear differences in financing cost and length to maturity can be observed (Brown and Riddiough (2003) and Highfield, Roskelley and Zhao (2007)), and REITs with banking relationships are more likely to have credit ratings (Hardin and Wu (2010)). Additionally, Campbell, Dodd, Hill and Kelly (2012 working paper) offer evidence that credit ratings are inversely related to dividend volatility and measures of financial constraints.This study compares and contrasts the effect of rating changes on REITs and non-REIT stocks. This is done by using the non-REIT group as a control group. The control group is created by a unique propensity score model based on multiple REIT characteristics. By creating a control group comprising of non-REIT stocks that are similar to the treatment group REITs, it gives us a chance to compare two set of entities that are similar on a set of characteristics. The data for this study is from 2003 to 2013. We use ratings from Moody’s, S&P and Dun and Bradstreet. The hypothesis that REITs are more transparent than non-REITs is tested by measuring market reaction to credit change announcements for both the groups that have been created.