Credit ratings for firms listed on the Oslo Stock Exchange – are ratings leading or lagging? : an event study

Abstract

This paper studies the effect of announcements by credit rating agencies (CRAs) on daily stock returns for firms listed on the Oslo Stock Exchange (OSE) and rated by S&P, Moody's and/or Fitch. The analysis is performed by utilizing event study methodology. Our main focus is announcements of core credit rating changes, but we also examine watch list announcements and aggregated announcements 1. We find a significant negative abnormal return in the case of credit rating downgrades, while we find no positive abnormal return in the case of upgrades. The same pattern is revealed, although with a smaller negative abnormal return, regarding both watch list and aggregated announcements. The analysis is performed on several samples of sub-categories. We find that the effects of negative announcements are more significant and larger for small firms than for large firms. There is evidence that an unexpected rating downgrade, meaning if the issuer is not put on a negative watch prior to the rating change, has a larger impact. Our results indicate that CRAs, to some extent, provide the financial markets with new information. In particularly, this applies for negative announcements. The reason for this is possibly that good news travels faster than bad news. Issuers might publish goods news immediately, while they are not in the same hurry with bad news and use a 3rd party like a CRA for this purpose. Although our study shows a significant negative abnormal return on the day of announcement, a substantial part of the total negative return occurs within a 120 day period prior to the announcement. This indicates that most of the information provided by the CRA is already known in the market. We describe and discuss the most well-known points of criticism against CRAs and their role. Many of these cause potential conflict of interest. The close relationship between the issuer and the CRA, and the fact that the issuer pays for their own rating is one of them. Other potential conflicts of interest are caused by the major CRAs’ dominating role in the market and the establishment of ancillary businesses in addition to the rating business.