The effects of credit ratings on stock returns in China

Domestic credit-rating agencies in China have been criticized for having no effect on the decisions of investors. We examine whether credit ratings and rating outlooks of the listed companies that are assigned by Chinese rating agencies have any effect on their stock returns. We use the pooled time-series cross-sectional issuer-rating data of 160 companies that are listed on the Shanghai and Shenzhen stock exchanges from Xinhua-Far East China Credit Ratings (a Hong Kong-based credit-ratings agency) for 2002 to 2004. Using a simultaneous equation model, we offer new insights into the determinants of Chinese credit ratings and whether credit ratings affect stock returns. The results suggest that profitability, debt structure, firm size, and past stock performance are important factors in determining Chinese credit ratings and rating outlooks. The model shows that credit ratings and the stock performance of the rated companies simultaneously influence each other. Chinese credit ratings are important to the stock returns of the rated issuers in China. Our empirical results provide preliminary evidence that contrasts the conceptual argument that credit ratings in China are not important to investors.