Financial structure of UK firms: The influence of credit ratings.
PhD thesis, University of Glasgow.
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Credit ratings have become a widely accepted measure of firms’ creditworthiness in financial markets. Despite the significant growth of rating agencies, with a continuous reliance on credit ratings by regulators, investors and firms, prior academic literature generally tends to underestimate the relevance of credit ratings in firms’ financial decision-making. This thesis, therefore, provides a comprehensive analysis, which aims to examine the impact of external credit ratings on the financial structure decision-making of UK firms. The thesis has three empirical chapters. The first empirical chapter examines whether there are any systematic differences in firms’ levels of leverage across the rating levels which would suggest that the cost and benefits of credit ratings are material for such firms. The study finds that credit ratings are an important determinant of the capital structures of firms and that there is a strong non-linear inverted U-shaped relationship between credit ratings and capital structures. It is noted that rated firms have higher leverage than non-rated firms, but within the rated firms, leverage varies across the rating levels. High and low rated firms are found to have low leverage in their capital structures, and mid rated firms generally have higher leverage. Low gearing ratios may suggest that such firms have higher incentive to maintain their current ratings or to achieve upgrades, given the cost and benefits offered by credit ratings, than firms with high gearing ratios.
The second empirical chapter investigates whether costs and benefits of credit ratings are material enough for potential and actual credit ratings changes to matter in the financial decision making of the firms. It does not appear from the empirical evidence that marginal changes in credit ratings possibly impose any serious costs on the rated UK firms. Whether credit ratings changes are potential or actual, they do not lead firms to follow any specific pattern with regards to their capital structure, which would suggest that firms are concerned about the marginal rating changes. Within the rating scale, however, some differences are noted among high and low rated firms. High (low) rated firms tend to issue (reduce) debt when they have a higher likelihood of upgrades. Similarly, high rated firms issue debt when they are actually upgraded or downgraded, while low rated firms are found only to reduce debt when they are upgraded indicating their efforts towards maintaining or achieving higher credit ratings.
The third empirical chapter examines the influence of credit ratings on the debt maturity structure of UK firms by testing Diamond’s (1991) liquidity hypothesis. Consistent with the predictions, the results indicate that firms’ debt maturity structures are significantly influenced by their levels of refinancing risk, and that this refinancing risk induces a strong non-linear relationship between credit ratings and debt maturity structures. It appears that high rated firms possibly have low levels of refinancing risk, which allows them to select debt with short maturity. Low rated and non-rated firms are also found to have shorter debt maturities, despite being exposed to high levels of refinancing risk. It appears that these firms may have constrained access to long-term debt markets and, therefore, they have to rely mostly on short-term debt. Mid rated firms, however, have more long-term debt, which appears to be due to their better access to debt markets as well as their exposure to some degree of refinancing risk.
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