The thesis examines whether the role of credit rating prior to the announcement of credit rating change is the neglected factor explaining in large extent the paradox investigated in prior papers that downgrades influence the stock prices of company but upgrades not. It is motivated by the notion that credit rating changes from low credit rating classes influence the stock price of company more distinctively than changes from higher credit rating classes and there is proportionally more downgrades from low credit rating classes than upgrades. The large sample of credit rating changes including proportionally more upgrades from low credit rating classes than downgrades is collected and the results suggesting the influence of downgrades on stock prices of company and any influence of upgrades persist. Furthermore when controlled for credit rating prior to the announcement of credit rating change, magnitude of credit rating change, crossing the investment-speculative barrier, credit rating changes within and across credit rating categories, consecutive credit rating changes in the same direction and industry sector of issuer all the results are consistent with the original conclusions proposing significant stock price reaction to announcements of credit rating downgrades and no stock price response to...

Issuers’ credit ratings change by one or more notches when credit rating agencies provide new ratings. Unique to the literature, I study the influences affecting multi notch versus single notch rating upgrades and downgrades. For Standard & Poors data, I show that rating changes with multiple notches provide more information to the market than single notch rating changes. Consistent with prior literature on the business cycle, I show that investors value good news rating changes (upgrades) more in bad times (recession) and that investors value bad news rating changes (downgrades) more in good times (expansion). I model and test probit models using variables capturing the characteristics of the previous issuer’s credit rating, liquidity, solvency, profitability, and growth opportunity to determine the classification of single notch versus multi notch rating changes. The determinants of multi notch versus single notch rating changes for upgrades and downgrades differ. Business cycle influences are evident. Firms that have multi notch rating upgrades and downgrades have significantly different probit variables vis-à-vis firms that have single notch rating upgrades and downgrades. The important characteristics for determining multiple notch upgrades are a firm’s prior rating change, prior rating, cash flow, total assets and market value. The important characteristics for determining multiple notch downgrades are a firm’s prior rating change, prior rating, current ratio, interest coverage, total debt, operating margin, market to book ratio, capital expenditure, total assets, market value, and market beta. The variables that differ for multi notch upgrades in recessions are cash flow, net income, operating margin, market to book ratio, total assets, and retained earnings. The variables that differ for multi notch downgrades in expansions are a firm’s prior rating change, current ratio, interest coverage ratio, debt ratio, total debt, capital expenditure and market beta. The power of the explanatory tests improves when the stage of the business cycle is considered. Results are robust to consideration of rating changes across rating categories, changes from probit to logit, alternative specifications of accounting variables, lags and leads of recessions and expansions timing, Fama and French industry adjustments, and winsorization levels of variables.