eThesis - Kauppakorkeakoulun sähköiset gradut

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OBJECTIVES OF THE STUDY:

In this thesis, I study how the credit rating of a company affects the information content, i.e., the stock price and trading volume reaction, of its earnings announcements in stock markets. I also examine how this impact differs between positive and negative earnings news as well as analyzing the effects of preceding rating changes. Finally, the study looks into how the relationship between ratings and informativeness of earnings announcements is affected by the level of information asymmetry surrounding firms and disclosure regulation changes. According to my knowledge, this is the first study to provide a more comprehensive view on the informational role of ratings around earnings announcements in stock markets.

DATA AND METHODOLOGY:

The empirical analysis of this study is based on 81,990 earnings announcements (from 2,765 unique firms) made in the US stock market by S&P rated firms in the period from February 1986 to December 2013. The methodology of this paper consists of traditional event study methods employing both univariate analysis and multivariate regressions where the information content of earnings releases is measured with cumulative abnormal returns and trading volumes over the [-1, +1] and [-2, +2] announcement windows. The impact of credit ratings is analyzed with different rating specifications.

RESULTS:

I find that the stock price and trading volume reactions around earnings disclosures are more pronounced for firms with lower ratings. For example, in the event of a negative earnings surprise, a one notch decrease in a company's credit rating is associated with a 0.25% more negative stock price reaction to earnings releases. Furthermore, a one notch lower credit rating results in 0.15% more of the outstanding shares being traded in the market around an earnings announcement. These findings indicate that lower ratings increase the information content of earnings releases and are in line with the univariate results of Greatrex (2009) but do not support the results of Leventis et al. (2014) who argue that higher ratings increase the informativeness of earnings announcements. Additional findings include that lower ratings are associated with even larger market reactions in the case of negative earnings surprises, when firms are characterized by more information asymmetry and when disclosure regulation changes increase the informational advantage of rating agencies. Preceding rating changes also increase the information content of earnings releases in some cases. Overall, my results are consistent with the hypothesis that better credit ratings reduce information asymmetry in financial markets.