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| Type | Bachelor's Thesis |
| Scope | Discipline-based scholarship |
| Title | The Influence of Credit Ratings on Capital Structure Decisions: Empirical Evidence for Europe |
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| Institution | University of Zurich |
| Faculty | Faculty of Business, Economics and Informatics |
| Number of Pages | 111 |
| Date | 2016 |
| Abstract Text | Initial situation and objective. Credit rating agencies play an important role in the global financial markets, reducing information asymmetries. Even though they have an increasingly bad reputation because of their poor risk assessment in the emergence of the latest financial crisis and the Enron scandal, they are still included in capital requirement and investment regulations in Europe. This leads to the assumption that credit ratings might be a substantial influence on managers’ capital structure decisions. In his seminal work, Kisgen (2006) introduced the Credit Rating - Capital Structure Hypothesis (CR-CS) where he adds credit ratings to the traditional determinants of capital structure decisions. The hypothesis implies that managers are concerned with discrete costs (benefits) associated with different credit rating levels and therefore consider them in their capital structure decisions. As Kisgen (2006) and most other papers on this matter focus on the US market, there is not much evidence as to what extent credit ratings influence capital structure decisions of European firms. The aim of this thesis is to empirically investigate the influence of credit ratings on capital structure decisions in Europe. To answer our research question, we adapt models proposed by Kisgen (2006) as well as refined tests introduced by Michelsen and Klein (2011). Methodology. The review of the background of credit ratings as well as the two traditional capital structure theories, the trade-off and the pecking order theory, build the theoretical foundation of our study. For the empirical analysis we use yearly financial data and Standard & Poor’s Long Term Issuer Rating and Rating Outlook. The main sample consists of 214 European companies over the period from 2000 to 2015 (16 years). Multiple regression models with fixed effects are used to analyze the panel data. To assess changes in capital structure, the dependent variable Net Debt Issuance is defined. The influence of credit ratings is measured by using various credit rating dummy variables and control variables that are known to be major determinants of leverage. Whereas Kisgen (2006) uses long term ratings alone, Michelsen and Klein (2011) add the Rating Outlook to determine if a firm is close to a potential rating change. To be able to compare our results and to see which approach gives more significant results, we apply both of the described methodologies. Three different potential changes in credit ratings are considered in this thesis. Firstly, Micro Rating changes from any rating to another (e.g. BB to BB-). Secondly, Broad Rating changes from one Broad Rating category to another (e.g. BBB+ to A-). And lastly we analyze the borderline of special importance between investment grade and speculative grade ratings (between BBB and BB). Results. The findings of this study only partially support the CR-CS Hypothesis. Including the Rating Outlook seems to be a more accurate way to determine a firm’s proximity to a rating change, returning more significant results. While most null hypotheses formulated cannot be rejected, we still get significant results indicating that managers are concerned with the costs of different credit rating levels. In contrast to Kisgen (2006), we do not find a symmetrical reaction. Firms seem to incur the costs of a potential negative rating change and issue approximately 1.4% less net debt relative to equity (as a percentage of total assets) than other firms in the subsequent financial year. Firms close to a positive rating change seem not to issue less net debt in order to incur the benefits of a higher rating. The results for Broad Rating changes are less significant. They show the same effect for negative rating changes as the Micro Rating tests. A potential upgrade to another Broad Rating level leads the average firm to issue more net debt relative to net equity (as a percentage of total assets) in the subsequent financial year. Being rated above the IGSG borderline seems to be of great importance with firms close to the borderline (above and below) issuing on average 2% less net debt relative to equity (as a percentage of total assets) than other firms in the subsequent financial year. This thesis adds to the existing capital structure theory showing that credit ratings do have an influence on capital structure decisions in Europe. Further research is needed to give conclusive evidence for the CR-CS or rather an adapted hypothesis. |
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