Management Earnings Guidance and Future Credit Rating Agency Actions

• In Event: Credit Ratings

Abstract

Credit rating agencies use both forward-looking and historical information in evaluating a firm’s credit risk, yet the role of forward-looking information in their rating decisions is not well understood. In this study, I examine the association between management earnings guidance news and future credit rating changes. While upward earnings guidance is not informative for credit rating changes, downward earnings guidance is significantly and positively associated with both the likelihood and speed of future rating downgrades. In cross-sectional analyses, I find that downward earnings guidance is particularly informative in two important circumstances: (i) when a firm’s current credit rating is overly optimistic compared with a model-predicted rating, and (ii) when the relevance or reliability of alternative information sources is lower. In addition, I find that downward earnings guidance is associated with lower future cash flows and a higher volatility of future cash flows. Overall, firms’ voluntary disclosure of bad earnings news seems to play a role in credit rating agencies’ decisions about whether and when to downgrade a firm.

Author

• An-Ping Lin, Singapore Management University