The effect of long-term bond rating changes on common stock prices in Europe

This paper uses daily common stock return data, surrounding credit rating changes by Moody’s Investors Service, in order to examine whether the absolute cumulative abnormal common stock return as a result of a credit rating downgrade is higher than the absolute cumulative abnormal common stock return after a credit rating upgrade. Put differently, it examines whether Moody’s conveys relatively more private information about a firm through a rating downgrade compared with a rating upgrade. An event study methodology is followed to measure the impact of a rating change on the value of the firm in the two-day window beginning the day of the press release by the rating agency. All rating changes by Moody’s related to Senior Unsecured Debt of firms of which the common stocks are listed on either the FTSE 100, AEX 25, BEL 20, DAX 30, IBEX 35 or CAC 40 index, during the examination period from 2007-2013, are included in the analysis. The rating change is classified as contaminated in the case that the firm released firm-specific data around the rating change. The result supports the reasoning that Moody’s conveys relatively more private information about a firm through a rating downgrade compared with a rating upgrade. In addition, multivariate cross-section regression analyses are performed to analyze the nature of the variance within the dependent variable, Abnormal Return. For each dataset related to either downgrades or upgrades the balanced panel data concerning two time series observations are analyzed. The most innovative explanatory variables included, are the Crisis dummy variable that controls for the financial crisis, and; the Investment dummy variable that controls for the old credit rating. For the regression analysis related to the uncontaminated downgrades dataset, the Crisis variable showed more pronounced negative price reactions during the financial crisis. In addition, the Investment variable showed that lower prior ratings are associated with larger negative Abnormal Returns.