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Article
Publication date: 23 November 2018

Guotai Chi and Bin Meng

The purpose of this paper is to propose a debt rating index system for small industrial enterprises that significantly distinguishes the default state. This debt rating system is…

Abstract

Purpose

The purpose of this paper is to propose a debt rating index system for small industrial enterprises that significantly distinguishes the default state. This debt rating system is constructed using the F-test and correlation analysis method, with the small industrial enterprise loans of a Chinese commercial bank as the data sample. This study establishes the weighting principle for the debt scoring model: “the more significant the default state, the larger is the weight.” The debt rating system for small industrial enterprises is constructed based on the standard “the higher the debt rating, the lower is the loss given default.”

Design/methodology/approach

In this study, the authors selected indexes that pass the homogeneity of variance test based on the principle that a greater deviation of the default sample’s mean from the whole sample’s mean leads to greater significance in distinguishing the default samples from the non-default samples. The authors removed correlated indexes based on the results of the correlation analysis and constructed a debt rating index system for small industrial enterprises that included 23 indexes.

Findings

Among the 23 indexes, the weights of 12 quantitative indexes add up to 0.547, while the weights of the remaining 11 qualitative indexes add up to 0.453. That is, in the debt rating of the small industry enterprises, the financial indexes are not capable of reflecting all the debt situations, and the qualitative indexes play a more important role in debt rating. The weights of indexes “X17 Outstanding loans to all assets ratio” and “X59 Date of the enterprise establishment” are 0.146 and 0.133, respectively; both these are greater than 0.1, and the indexes are ranked first and second, respectively. The weights of indexes “X6 EBIT-to- current liabilities ratio,” “X13 Ratio of capital to fixed” and “X78 Legal dispute number” are between 0.07 and 0.09, these indexes are ranked third to fifth. The weights of indexes “X3 Quick ratio” and “X50 Per capital year-end savings balance of Urban and rural residents” are both 0.013, and these are the lowest ranked indexes.

Originality/value

The data of index i are divided into two categories: default and non-default. A greater deviation in the mean of the default sample from that of the whole sample leads to greater deviation from the non-default sample’s mean as well; thus, the index can easily distinguish the default and the non-default samples. Following this line of thought, the authors select indexes that pass the F-test for the debt rating system that identifies whether or not the sample is default. This avoids the disadvantages of the existing research in which the standard for selecting the index has nothing to do with the default state; further, this presents a new way of debt rating. When the correlation coefficient of two indexes is greater than 0.8, the index with the smaller F-value is removed because of its weaker prediction capacity. This avoids the mistake of eliminating an index that has strong ability to distinguish default and non-default samples. The greater the deviation of the default sample’s mean from the whole sample’s mean, the greater is the capability of the index to distinguish the default state. According to this rule, the authors assign a larger weight to the index that exhibits the ability to identify the default state. This is different from the existing index system, which does not take into account the ability to identify the default state.

Details

Management Decision, vol. 57 no. 9
Type: Research Article
ISSN: 0025-1747

Keywords

Article
Publication date: 18 May 2015

Finn Marten Körner and Hans-Michael Trautwein

The purpose of this paper is to test the hypothesis that major credit rating agencies (CRAs) have been inconsistent in assessing the implications of monetary union membership for…

Abstract

Purpose

The purpose of this paper is to test the hypothesis that major credit rating agencies (CRAs) have been inconsistent in assessing the implications of monetary union membership for sovereign risks. It is frequently argued that CRAs have acted procyclically in their rating of sovereign debt in the European Monetary Union (EMU), underestimating sovereign risk in the early years and over-rating the lack of national monetary sovereignty since the onset of the Eurozone debt crisis. Yet, there is little direct evidence for this so far. While CRAs are quite explicit about their risk assessments concerning public debt that is denominated in foreign currency, the same cannot be said about their treatment of sovereign debt issued in the currency of a monetary union.

Design/methodology/approach

While CRAs are quite explicit about their risk assessments concerning public debt that is denominated in foreign currency, the same cannot be said about their treatment of sovereign debt issued in the currency of a monetary union. This paper examines the major CRAs’ methodologies for rating sovereign debt and test their sovereign credit ratings for a monetary union bonus in good times and a malus, akin to the “original sin” problem of emerging market countries, in bad times.

Findings

Using a newly compiled dataset of quarterly sovereign bond ratings from 1990 until 2012, the panel regression estimation results find strong evidence that EMU countries received a rating bonus on euro-denominated debt before the European debt crisis and a large penalty after 2010.

Practical implications

The crisis has brought to light that EMU countries’ euro-denominated debt may not be considered as local currency debt from a rating perspective after all.

Originality/value

In addition to quantifying the local currency bonus and malus, this paper shows the fundamental problem of rating sovereign debt of monetary union members and provide approaches to estimating it over time.

Details

The Journal of Risk Finance, vol. 16 no. 3
Type: Research Article
ISSN: 1526-5943

Keywords

Open Access
Article
Publication date: 24 July 2019

Bora Aktan, Şaban Çelik, Yomna Abdulla and Naser Alshakhoori

The purpose of this paper is to empirically investigate the effect of real credit ratings change on capital structure decisions.

15743

Abstract

Purpose

The purpose of this paper is to empirically investigate the effect of real credit ratings change on capital structure decisions.

Design/methodology/approach

The study uses three models to examine the impact of credit rating on capital structure decisions within the framework of credit rating-capital structure hypotheses (broad rating, notch rating and investment or speculative grade). These hypotheses are tested by multiple linear regression models.

Findings

The results demonstrate that firms issue less net debt relative to equity post a change in the broad credit ratings level (e.g. a change from A- to BBB+). The findings also show that firms are less concerned by notch ratings change as long the firms remain the same broad credit rating level. Moreover, the paper indicates that firms issue less net debt relative to equity after an upgrade to investment grade.

Research limitations/implications

The study covers the periods of 2009 to 2016; therefore, the research result may be affected by the period specific events such as the European debt crisis. Moreover, studying listed non-financial firms only in the Tadawul Stock Exchange has resulted in small sample which may not be adequate enough to reach concrete generalization. Despite the close proximity between the GCC countries, there could be jurisdictional difference due to country specific regulations, policies or financial development. Therefore, it will be interesting to conduct a cross country study on the GCC to see if the conclusions can be generalized to the region.

Originality/value

The paper contributes to the literature by testing previous researches on new context (Kingdom of Saudi Arabia, KSA) which lack sophisticated comparable studies to the one conducted on other regions of the world. The results highlight the importance of credit ratings for the decision makers who are required to make essential decisions in areas such as financing, structuring or operating firms and regulating markets. To the best of the authors’ knowledge, this is the first study of its kind that has been applied on the GCC region.

Details

ISRA International Journal of Islamic Finance, vol. 11 no. 2
Type: Research Article
ISSN: 0128-1976

Keywords

Article
Publication date: 13 July 2022

Reza Tahmoorespour, Mohamed Ariff, Yaasmin Farzana Abdul Karim, Kian Tek Lee and Sharon Dharsini Anthony

This manuscript reports evidence on how debt-taking decisions of top management in a multi-country setting do affect credit rating scores assigned by credit rating agencies (CRAs…

Abstract

Purpose

This manuscript reports evidence on how debt-taking decisions of top management in a multi-country setting do affect credit rating scores assigned by credit rating agencies (CRAs) as global monitors of creditworthiness of borrowers. This aspect has been long ignored by researchers in the literature. The purpose of this paper is twofold. A test model is specified first using theories to connect debt-taking behavior to credit rating scores. Once that model helps to identify a number of statistically significant factors, the next step helps to identify threshold values at which the variables driving debt-taking behavior would worsen the credit rating scores as turning points of the thresholds.

Design/methodology/approach

The study identifies factors driving creditworthiness scores due to debt-taking behavior of countries and develops a correct research design to identify a model that explains (1) credit rating scores and the factors driving the scores and runs (2) panel-type regressions to test model fit. Having found factors driving debt-taking behavior by observed units, the next step identifies threshold values of factors at which point further debt-taking is likely to worsen credit rating risk of the observed units. This is a robustness test of the methodology used. The observed units are 20 countries with data series across 14 years.

Findings

First, new findings suggest there are about six major factors associated with debt-taking behavior and credit rating changes. Second, the model developed in this study is able to account for substantial variability while the identified factors are statistically significant within the normal p-values for acceptance of hypotheses. Finally, the threshold values of factors identified are likely to be useful for managerial decisions to judge the levels at which further debt-taking would worsen the credit rating scores of the observed units.

Research limitations/implications

The observed units are from 20 countries over 14 years of annual data available on credit rating scores (privately obtained from Standard and Poor [S&P]). The sample represents major economies but did not include emerging countries. In that regard, it will be worthwhile to explore the debt-taking behavior of emerging economies in a future study using the methodology verified in this study.

Practical implications

The findings help add few useful guidelines for top management decisions. (1) There are actually factors that are associated with debt-taking behavior, so the authors now know these factors as guides for managerial actions. (2) The authors are free to state that the credit rating changes occur on objective changes in the factors found as significantly related to the debt-taking behavior. (3) The threshold values of key factors are known, so top management could use these threshold values of named factors to monitor if a debt-taking decision is going to push the credit rating to a worse score.

Social implications

There are society-wide implications. Knowing that the world's debt level is high at US$2.2 for each gross domestic product (GDP) dollar across almost 200 countries, any knowledge on what factors help drive creditworthiness scores, thus credit riskiness, is revealed in this paper. Knowing those factors and also knowing the turning points of the factors – the threshold values – likely to worsen creditworthiness scores is a powerful tool for controlling excessive debt-taking by an observation unit included in this study (The dataset in this research can also be used to see inter-temporal movement on debt-taking in a future study).

Originality/value

In the authors' view, there are many studies on debt-taking behavior. But none has connected debt-taking on how (1) named factors are observable to management that affect credit rating changes and (2) if a factor affects creditworthiness, at which point of the factor value, the creditworthiness will flip to worsen the score. These aspects are seldom found in the literature. Hence, the paper is original with practical value at the global level.

Details

International Journal of Managerial Finance, vol. 19 no. 3
Type: Research Article
ISSN: 1743-9132

Keywords

Book part
Publication date: 14 November 2012

Clea Bourne

Purpose – The purpose of this chapter is to explore the voluntary corporate governance role played by credit rating agencies, closing the ‘trust at a distance’ gap which might…

Abstract

Purpose – The purpose of this chapter is to explore the voluntary corporate governance role played by credit rating agencies, closing the ‘trust at a distance’ gap which might otherwise hinder fundraising in debt capital markets.

Methodology/approach – The chapter draws on Giddens’ system trust theory and Foucauldian perspectives of knowledge/power to unpack trust production as a discursive process in financial markets. Foucauldian discourse analytic techniques are used to examine texts deployed by or about Standard & Poor's, the global credit rating agency, leading up to the 2007 credit crunch.

Findings – The texts analysed illustrate the influence of rating agencies in producing trust as well as mistrust in debt instruments.

Research limitations/implications – Rating agencies produce trust by aligning with state regulatory systems, simplifying complex debt instruments with ‘AAA’ and other well-known mnemonics, as well as offering apparent transparency and guarantees.

Practical implications – While influential, rating agencies can only produce trust by proxy. Their contribution to the actual protection of investments is minimal.

Social implications – The analysis highlights the flawed nature of trust relations in debt capital markets as rating agencies’ primary customers are the arrangers and issuers of debt rather than the investors who seek protection from risk.

Originality/value – The chapter sheds light on the deliberate nature of trust production in financial markets. Five trust/mistrust production practices are introduced – protecting, guaranteeing, aligning, making visible and simplifying. Strategic trust production is established as part of corporate governance ideology in financial markets.

Details

Corporate Social Irresponsibility: A Challenging Concept
Type: Book
ISBN: 978-1-78052-999-8

Keywords

Article
Publication date: 28 December 2021

Huan Yang and Jun Cai

The question is whether debt market investors see through managers' attempts to hide their pension obligations. The authors establish a robust relation between understated pension…

Abstract

Purpose

The question is whether debt market investors see through managers' attempts to hide their pension obligations. The authors establish a robust relation between understated pension liabilities and corporate bond yield spreads after controlling for factors that have been previously identified as having a significant impact on firms' cost of borrowing. The results support the idea that bond market investors are not being misled by the use of high pension liability discount rates by some companies to lower their reported pension obligations. For a small fraction of debt issuers, the reported pension liabilities are larger than the pension liabilities valued at the stipulated interest rate benchmarks. For these issuers with overstated pension liabilities, bond investors adjust their borrowing costs downward.

Design/methodology/approach

The authors investigate the relation between corporate bond yield spreads and understated pension liabilities relative to long-term Treasury and high-grade corporate bond yields. They aim to answer two questions. First, what are the sizes of over or understated pension liabilities relative to guideline benchmarks? Second, do debt market investors see through the potential management manipulation of pension discount rates? The authors find that firms with large understated pension liabilities face higher marginal borrowing costs after taking into account issue-specific features, firm characteristics, macroeconomic conditions and other pension information such as funded status and mandatory contributions.

Findings

The average understated projected benefit obligations (PBOs) are understated by $394.3 and $335.6, equivalent to 3.5 and 3.0% of the beginning of the fiscal year market value, respectively. The average understated accumulated benefit obligations (ABOs) are understated by $359.3 and $305.3 million, equivalent to 3.1 and 2.6%, of the beginning of the fiscal year market value, respectively. Relative to AA-grade corporate bond yields, the average difference between firm pension discount rates and benchmark yields becomes much smaller; the percentage of firm pension discount rates higher than benchmark yields is also much smaller. As a result, understated pension liabilities become negligible. The authors establish a robust relation between corporate bond yield spreads and measures of understated pension liabilities after controlling for issue-specific features, firm characteristics, other pension information (funded status and mandatory contributions), macroeconomic conditions, calendar effects and industry effects.

Originality/value

S&P Rating Services recognizes the issue that there is considerably more variability in discount rate assumptions among companies than in workforce demographics or the interest rate environment in which firms operate (Standard and Poor's, 2006). S&P also indicates that it would be desirable to normalize different discount rate assumptions but acknowledges that it is difficult to do so. In practice, S&P Rating Services conducts periodic surveys to see whether firms' assumed discount rates conform to the normal standard. The paper makes an initial attempt to quantify the size of understated pension liabilities and their impact on corporate bond yield spreads. This approach can be extended to study firms' costs of equity capital, the pricing of seasoned equity offerings and the pricing of merger and acquisition transaction deals, among other questions.

Details

China Finance Review International, vol. 12 no. 1
Type: Research Article
ISSN: 2044-1398

Keywords

Article
Publication date: 2 May 2017

Allen M. Featherstone, Christine A. Wilson and Lance M. Zollinger

The purpose of this paper is to examine empirical customer account data from 2006 through 2012 to review the probability of default (PD) rating methodology implemented by a FCS…

Abstract

Purpose

The purpose of this paper is to examine empirical customer account data from 2006 through 2012 to review the probability of default (PD) rating methodology implemented by a FCS association for production agricultural accounts. This analysis provides insight into the migration of accounts across the association’s currently established PD rating categories with negative migration being a precursor to potential loan default.

Design/methodology/approach

The data set contained 17,943 observations from the years 2006 to 2012 and consisted of various fields of data including balance sheet date, earnings statement date, and PD rating as of the statement date. The methods include analysis on the dynamics of the PD ratings and component ratios. OLS regression was used to analyze the data to see how the current period PD rating and component ratios affected the PD rating one year, three years, and five years out. OLS regression examined the statistical significance of the PD ratings and ratio components for this analysis. The dependent variable, Future PD Rating, represents the assigned PD rating for the observed farm either one, three, or five years into the future. It is expected that the initial PD rating in any given year would have a positive relationship, and be statistically significant in estimating future PD ratings. The independent variables are the current PD rating and the various component ratios of the inverse current ratio (CR), the debt to asset ratio (D/A), the gross profit to total liabilities ratio, the inverse debt coverage ratio, working capital to gross profit, and funded debt to EBITDA.

Findings

Results indicate that financial ratio information gathered today can do a good job forecasting PD ratings up to three years in the future. CR information does not forecast five years into the future very well. Thus, there is an important need to update financial information on a regular basis. The results indicate that the D/A information is very important in predicting risk ratings. As the production agriculture sector has experienced difficult financial conditions during 2014 and 2015, agricultural finance institutions need to obtain up-to-date financial information from their clientele to effectively assess the risk of and manage their financial portfolio.

Originality/value

Several previous works have examined and established models to assess risk in agricultural lending. This research adds to this body of work by examining the migration of an account’s risk-rating class over time using actual lender account data.

Details

Agricultural Finance Review, vol. 77 no. 1
Type: Research Article
ISSN: 0002-1466

Keywords

Book part
Publication date: 26 February 2016

Noel Cassar and Simon Grima

The recent development of the European debt sovereign crisis showed that sovereign debt is not “risk free.” The traditional index bond management used during the last two decades…

Abstract

Introduction

The recent development of the European debt sovereign crisis showed that sovereign debt is not “risk free.” The traditional index bond management used during the last two decades such as the market-capitalization weighting scheme has been severely called into question. In order to overcome these drawbacks, alternative weighting schemes have recently prompted attention, both from academic researchers and from market practitioners. One of the key developments was the introduction of passive funds using economic fundamental indicators.

Purpose

In this chapter, the authors introduced models with economic drivers with an aim of investigating whether the fundamental approaches outperformed the other models on risk-adjusted returns and on other terms.

Methodology

The authors did this by constructing five portfolios composed of the Eurozone sovereigns bonds. The models are the Market-Capitalization RP, GDP model RP, Ratings RP model, Fundamental-Ranking RP, and Fundamental-Weighted RP models. These models were created exclusively for this chapter. Both Fundamental models are using a range of 10 country fundamentals. A variation from other studies is that this dissertation applied the risk parity concept which is an allocation technique that aims to equalize risk across different assets. This concept has been applied by assuming the credit default swap as proxy for sovereign credit risk. The models were run using the Generalized Reduced Gradient (GRG) method as the optimization model, together with the Lagrange Multipliers as techniques and the Karush–Kuhn–Tucker conditions. This led to the comparison of all the models mentioned above in terms of performance, risk-adjusted returns, concentration, and weighted average ratings.

Findings

By analyzing the whole period between 2006 and 2014, it was found that both the fundamental models gave very appealing results in terms of risk-adjusted returns. The best results were returned by the Fundamental-Ranking RP model followed by the Fundamental-Weighting RP model. However, better results for the mixed performance and risk-adjusted returns were achieved on a yearly basis and when sub-dividing the whole period in three equal periods. Moreover, the authors concluded that over the long term, the fundamental bond indexing triumphed over the other approaches by offering superior return and risk characteristics. Thus, one can use the fundamental indexation as an alternative to other traditional models.

Details

Contemporary Issues in Bank Financial Management
Type: Book
ISBN: 978-1-78635-000-8

Keywords

Article
Publication date: 13 November 2023

Solomon Opare and Md. Borhan Uddin Bhuiyan

This research aims to revisit Gul and Goodwin (2010), which focuses on exploring the relationship between debt maturity structure, credit ratings and audit fees. Furthermore, the…

Abstract

Purpose

This research aims to revisit Gul and Goodwin (2010), which focuses on exploring the relationship between debt maturity structure, credit ratings and audit fees. Furthermore, the authors investigate whether this association varies based on firm size, firm life cycle and financial reporting quality.

Design/methodology/approach

To investigate the research question, the authors use an extended sample period, 2004–2017, in comparison to the sample period, 2003–2006, used in Gul and Goodwin (2010). The authors use ordinary least squares regression as a baseline methodology along with two-stage least-squares regression and change analysis to control for endogeneity concerns.

Findings

According to Gul and Goodwin (2010), auditors charge lower audit fees for firms with higher short-maturity debt and better credit ratings, indicating a lower likelihood of financial misreporting. Further, Gul and Goodwin (2010) find that lower credit rated firms benefit more from short-term debt. Primarily, the findings are consistent with Gul and Goodwin (2010) and provide further evidence that the beneficial effects of short-maturity debt for firms with poor ratings are evident for small firms, firms in the growth stage of their life cycle and firms with poor earnings quality.

Practical implications

The findings imply that practitioners in the audit profession and investors should take a more nuanced and comprehensive approach to varied firm and financial factors, taking into consideration the intricate relationships between many elements impacting a firm’s financial health. As a result, audit professionals may give more accurate appraisals of a firm’s financial condition, and investors can make better investment decisions.

Originality/value

The authors reconfirm the findings of Gul and Goodwin (2010) using an extended sample. The findings are novel, which evidence that the lower audit fees for rated firms with short-maturity debt are moderated by firm size, life cycle and financial reporting quality.

Details

Accounting Research Journal, vol. 36 no. 6
Type: Research Article
ISSN: 1030-9616

Keywords

Article
Publication date: 7 November 2016

Weerakoon Banda Yatiwelle Koralalage

The purpose of this paper is to examine the managerial views on the corporate financing practices of firms in the emerging market of Sri Lanka.

2049

Abstract

Purpose

The purpose of this paper is to examine the managerial views on the corporate financing practices of firms in the emerging market of Sri Lanka.

Design/methodology/approach

A survey approach was employed using chief financial officers (CFOs) from the top non-financial firms listed on the Colombo Stock Exchange.

Findings

CFOs’ views on corporate financing practices are not fully consistent with the theory: financial hierarchy appears to be more important and firms are less leveraged. Most Sri Lankan CFOs perceive some policy factors as important and theoretically support: volatility of earnings and cash flows, tax advantages of interest deductibility, transaction costs, timing of interest rates, low foreign interest rates and debt equity targets. These factors are high priority in emerging markets but either not important at all or less important in developed markets. Matching debt maturity with the life of assets is equally important in both markets. Most CFOs adhere their financing to the local debt market, while a few firms use foreign debt. CFOs are concerned about earnings per share (EPS) dilution, providing a natural hedge in foreign debt issues, credit ratings, under/overvaluation of stocks and corporate control, whereas they are significantly important in developed markets. Age and education mostly explain the differences.

Research limitations/implications

The study is restricted to large companies in a relatively smaller market. Hence, sample size is relatively small, even though it shows a higher response rate.

Practical implications

The study offers insights for corporate financing decision-makers that could impact on firm value through a shift in emphasis toward capital structure theories.

Originality/value

The paper focuses on corporate financing practices in Sri Lanka in search of emerging market features that could mitigate the gap in the emerging market literature through survey evidence.

Details

Qualitative Research in Financial Markets, vol. 8 no. 4
Type: Research Article
ISSN: 1755-4179

Keywords

1 – 10 of over 31000