Initial credit ratings and earnings management

K. Ozgur Demirtas, Kimberly Rodgers Cornaggia

Research output: Contribution to journalArticle

8 Citations (Scopus)

Abstract

Credit rating agencies assert that they rely on financial information provided by issuers and that they value rating stability as well as accuracy. In an environment where rating agencies depend on issuer-reported information and are reluctant to adjust ratings promptly, managers of issuing firms can utilize the discretion afforded by GAAP to obtain the most favorable credit ratings. Consistent with our expectations, we find that current accruals are unusually positive and high around initial credit ratings. The increase in abnormally high accruals leading up to the initial credit rating year is followed by a reversal in the subsequent years. Multivariate regression analyses suggest that accounting accruals, abnormal current accruals in particular, are significantly positively related to initial credit ratings after controlling for several issue- and issuer-related characteristics indicative of default risk. Our results are robust to additional tests that account for endogeneity between credit ratings and earnings management, adjust for performance, and account for firms issuing debt and equity simultaneously.

Original languageEnglish (US)
Pages (from-to)135-145
Number of pages11
JournalReview of Financial Economics
Volume22
Issue number4
DOIs
StatePublished - Nov 1 2013

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Earnings management
Credit rating
Accruals
Rating
Credit rating agencies
Default risk
Debt
Equity
Rating agencies
Endogeneity
Multivariate regression
Financial information
Reversal
Accounting accruals
Discretion
Managers

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Cite this

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abstract = "Credit rating agencies assert that they rely on financial information provided by issuers and that they value rating stability as well as accuracy. In an environment where rating agencies depend on issuer-reported information and are reluctant to adjust ratings promptly, managers of issuing firms can utilize the discretion afforded by GAAP to obtain the most favorable credit ratings. Consistent with our expectations, we find that current accruals are unusually positive and high around initial credit ratings. The increase in abnormally high accruals leading up to the initial credit rating year is followed by a reversal in the subsequent years. Multivariate regression analyses suggest that accounting accruals, abnormal current accruals in particular, are significantly positively related to initial credit ratings after controlling for several issue- and issuer-related characteristics indicative of default risk. Our results are robust to additional tests that account for endogeneity between credit ratings and earnings management, adjust for performance, and account for firms issuing debt and equity simultaneously.",
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Initial credit ratings and earnings management. / Demirtas, K. Ozgur; Rodgers Cornaggia, Kimberly.

In: Review of Financial Economics, Vol. 22, No. 4, 01.11.2013, p. 135-145.

Research output: Contribution to journalArticle

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