The Determinants of creditworthiness : an empirical study of the relationship between credit ratings and financial ratios in the E&P industry

Abstract

This thesis investigates the usefulness of financial ratios in explaining the variation observed in Standard and Poor’s credit ratings within the E&P industry. Culminating from a cross-sectional study of 82 E&P companies at year-end 2012, we propose a multinomial logit model consisting of three financial ratios that correctly classifies the ratings of 59.8 and 49.4 percent of in-sample and out-of-sample observations, respectively. If the model is reduced to only classify ratings as investment grade and speculative grade, the share of correctly classified ratings increases to 84.1 and 83.1 percent. The three retained ratios are Net Debt Ratio, Coverage Ratio and Cash Flow per BOE. Our analysis implies that a non-linear model with only three financial ratios captures a considerable share of the determinants of credit ratings among E&P companies.