Credit Ratings and Firm Innovation: Evidence from Sovereign Downgrades

Rui WANG, Shijie YANG*

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)peer-review

1 Citation (Scopus)

Abstract

This study investigates the relationship between credit ratings and firm innovation activities using a cross-country sample over the 1995–2020 period. Exploiting the setting of rating agencies’ sovereign ceiling policies, our main analysis shows that a one-notch reduction in corporate credit ratings engendered by sovereign downgrades, on average, leads to a 5.90% reduction in research and development (R&D) spending. We identify the substitution of external acquisitions for internal expenditures and the increase in creditor control as the underlying mechanisms of the causal relation. Moreover, the negative impact of credit rating downgrades on R&D investment results in deterioration in patent output and firm performance. The cross-sectional analysis shows that the observed effects on innovation and firm performance are concentrated in firms with higher external finance dependence or more growth options.
Original languageEnglish
Article number106719
Number of pages16
JournalJournal of Banking and Finance
Volume148
DOIs
Publication statusE-pub ahead of print - 7 Nov 2022

Bibliographical note

The authors are grateful to Carol Alexander (the Editor), an anonymous Associate Editor, two anonymous reviewers, Ling Cen, David Denis, Micah Officer, Jong-Min Oh (CICF discussant), Lynnette Purda (EFA discussant), Xuan Tian, Matthew Wynter (FMA discussant), Tong Zhou, Hong Zou, conference participants at the 2018 China International Conference in Finance, the 2018 Eastern Finance Association Annual Meeting, the 2018 Financial Management Association Annual Meeting, the 2018 Hong Kong Junior Accounting Faculty Conference, and the 2019 New Zealand Finance Meeting, as well as seminar participants at Tsinghua University for helpful comments and suggestions.

Keywords

  • Credit ratings
  • corporate innovation
  • Sovereign Rating downgrade
  • Creditor Control
  • Mergers and acquisitions

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