Credit Ratings and Managerial Voluntary Disclosures

Published date01 May 2018
Date01 May 2018
The Financial Review 53 (2018) 337–378
Credit Ratings and Managerial Voluntary
Guanming He
University of Durham
This study investigates whether managers influence credit ratings via voluntary disclo-
sures. I find that firms near a rating change have a higher incidence of a disclosure regarding
product and business expansion (PBE) plans. This finding is more evident for firms that are
subject to lower proprietary costs of disclosures, which implies that managers do trade off both
the benefits and costs of the disclosures. I find no evidence that firms close to a rating change
selectively release good news or suppress bad news on PBE. Overall, my results suggest that
firms generally exhibit a credible commitment to maintaining disclosure transparency for a
desired credit rating.
Keywords: credit ratings, information transparency, commitment to disclosures, product and
business expansion plans
JEL Classifications: M41, G24
Corresponding author: Durham University Business School, Queen’sCampus, Wolfson Building, Room
H120, University Boulevard, Thornaby, Stockton on Tees, United Kingdom; Phone: +44-7570184501;
I appreciate the helpful comments or advice from Srinivasan Krishnamurthy,an anonymous reviewer, Bin
Ke, Clive Lennox, Chuanyang Hwang, Stephen Dimmock, Siew Hong Teoh, Stephen Penman, Samuel
Bonsall (the AAA discussant), Michelle Hanlon, April Klein, Wim Van der Stede, Gary Biddle, Chul
Park, Zhaoyang Gu, Huai Zhang, Irem Tuna, and seminar participants at London school of Economics
and Political Science, Nanyang Technological University, University of Warwick, University of Hong
Kong, Chinese Universityof Hong Kong, University of Sydney, University of Lethbridge, 2013 American
Accounting Association annual meeting, UTS Emerging Accounting Research consortium, and 26th
International Business Research conference. This paper won a best paper award at the 26th International
Business Research Conference. Part of the research was conducted when I was affiliated with Nanyang
Technological Universityand University of Warwick, respectively. All errors are my own.
C2018 The Eastern Finance Association 337
338 G. He/The Financial Review 53 (2018) 337–378
1. Introduction
Credit ratings are important for a firm due to their impact on stock and bond
valuations and to the regulatory and contractual costs (benefits) associated with a
credit rating change (Kisgen, 2006). Thus, managers have an incentive to maintain
or achieve a desired credit rating through influencing rating agencies’ perceptions
about corporate creditworthiness. Existing literature shows that the costs (benefits)
associated with a credit rating change affect managerial capital structure decisions
(e.g., Kisgen, 2006, 2007, 2009) and corporate financing choices (Hovakimian,
Kayhan and Titman, 2010), and that firms tend to adjust leverage to influence rating
agencies’ decisions. However, leverage is not the only concern for rating agencies in
determining a firm’s credit rating. The rating process also requires analysis of pub-
licly disclosed corporate information that is associated with a firm’s creditworthiness
(Standard & Poor’s, 2009).
The objective of this study is to investigate how managers take advantage of
voluntary disclosures to fulfill their incentives for a desired credit rating. I address
this issue by probing managers’ disclosure strategies that are in response to an
impending credit rating change. In this study, firms close to a rating change are
defined as those near a threshold credit category per Kisgen (2006).1I focus on
disclosures as to product and business expansion (PBE) plans for two reasons. First,
every firm has PBE plans and their announcements occur frequently in practice
(Nichols, 2010); hence, the focus on PBE disclosures facilitates a large sample anal-
ysis. Second, PBE disclosures represent a typical form of voluntary disclosure that
implies long-term streams of a firm’s future earnings. As a credit rating is meant
to discriminate a firm’s credit risk on a long horizon (Altman and Rijken, 2004;
Standard & Poor’s, 2009; Hovakimian, Kayhan and Titman, 2010), PBE disclosures
might substantially affect rating decisions.2Furthermore, PBE plans are discussed,
ascertained, and finalized internally by management and then released publicly. To
ensure stability of credit ratings, rating agencies tend not to rely on uncertain cor-
porate information in their credit analyses. Even if a firm releases its PBE plans
privately to the rating agencies, the plans might not be factored into credit ratings
until after the public announcements of those plans. Hence, it is likely that impending
credit rating changes influence managers’ public disclosure strategies regarding PBE
Rating agencies rely critically on projected future cash flow to assess a firm’s
ability to meet financial obligation. A decrease in information asymmetry be-
tween insiders and outsiders has positive effects on a firm’s future cash flow,
1The precise definitions used for empirical analysis are described in the latter part of the Introduction
2As stated by Standard & Poor’s (S&P) rating agency, “credit ratings are meant to be forward-looking
in measuring long-term credit risk and the time horizon extends as far as is analytically foreseeable
(Standard & Poor’s, 2009, emphasis in the original).
G. He/The Financial Review 53 (2018) 337–378 339
thereby increasing a firm’s creditworthiness perceived by rating agencies (e.g.,
Ashbaugh-Skaife, Collins and LaFond, 2006). The positive effects lie along three
dimensions. First, a decrease in information asymmetry mitigates agency risk faced
by all external stakeholders. For example, low information asymmetry that facili-
tates the monitoring of management practices could curb opportunistic management
behavior that decreases firm value and promote better managerial decision making
that increases firm value. Low information asymmetry is conducive to establishing
or maintaining a robust supplier-customer relationship, helping a firm generate sus-
tainably high profits. Second, low information asymmetry enables a firm to raise full
capital as planned on a timely basis, so that the firm would not miss out on some
promising investment opportunities to enlarge future profits. Third, a decrease in in-
formation asymmetry reduces outside investors’ estimation risk and thereby lowers a
firm’s cost of capital (e.g., Easley and O’Hara, 2004; Lambert, Leuz and Verrecchia,
Prior literature (e.g., Lev and Penman, 1990; Welker, 1995; Dhaliwal, Li, Tsang
and Yang,2011) shows that managers could voluntarily disclose value-relevant infor-
mation to outsiders to reduce information asymmetry between insiders and outsiders.
Hence, voluntary disclosure is an instrument through which managers may influence
credit ratings. PBE disclosure is such an instrument, in that it has implications for
long-term streams of a firm’s future earnings and reduces information asymmetry. As
rating agencies claim to have incorporated information transparency into the assess-
ment of a firm’s creditworthiness, firmsthat wish for a desired credit rating would be
more likely to disclose their PBE plans. These disclosures also reduce the uncertainty
of whether a firm would followthrough with its plans, thereby reduce rating agencies’
estimation risk in respect to a firm’s future cash flow, and in turn, increase a firm’s
creditworthiness perceived by rating agencies.
Rating agencies face widespread criticism for their failure to adjust for oppor-
tunistic corporate reporting (e.g., SEC, 2003). They generally do not conduct audits
or due diligence reviews of client-provided information. So, managers with an in-
centive to pursue a desired credit rating might selectively disclose good news in the
belief that rating agencies might not be able to undo and adjust for the selective good
news disclosures. Rating agencies, should they fail to undo a firm’s selective good
news disclosures, would perceive the firm as having high information transparency
and low credit risk. However, a credit rating is maintained by a firm for long time,
which constitutes a repeated game between managers and rating agencies. In repeated
games, managers can benefit from building up a reputation for credible disclosures
(Stocken, 2000; Beyer, Cohen, Lys and Walther, 2010). By contrast, if managers
selectively release good news or suppress bad news, this might temporarily deceive
rating agencies, but would be penalized for the cheating once it is detected. In the case
of such detection, the firm would be perceived as lacking information transparency
in spite of the incidence of the good news disclosures. Therefore, conditional on a
manager’s decision to voluntarily disclose PBE plans, whether he/she would selec-
tively release good news or suppress bad news for a desired credit rating becomes

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