Cash Flow Management and Credit Rating Properties

• In Event: Credit ratings
  In Paper Session: Credit Ratings

Abstract

This paper examines the impact of cash flow management on the properties of bond ratings. Based on a sample of bonds issued by U.S. firms, we find firms that manage cash flow from operations (CFO) exhibit more favorable bond ratings in the future. Moreover, we find CFO management results in a deterioration in the ability of credit ratings to predict debt default, a higher frequency of missed defaults (i.e., more Type I errors), a lower frequency of assigning too harsh ratings to non-defaulting issues (i.e., fewer Type II errors), and a weaker relation between bond ratings and bond yields. We also find considerable heterogeneity with respect to the impact of CFO management in that its effects are more pronounced for large debt issuers and generally less pronounced for financially constrained firms. Taken together, our evidence highlights the range of adverse effects of CFO management on the quality of bond ratings.

Authors

• Inder Khurana, University of Missouri–Columbia

• Raynolde Pereira, University of Missouri–Columbia

• Xia Zhang, University of Missouri–Columbia