The roles of rating outlooks: the predictor of creditworthiness and the monitor of recovery efforts

Winnie P. H. POON, Jianfu SHEN*

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)

Abstract

Using a comprehensive U.S. rating sample from S&P between 1981 and 2015, we examine the information content, responsiveness to credit risk and recovery efforts associated with rating outlooks. We find that rating outlooks (and credit watches) have important information content and are significantly associated with creditworthiness, measured by expected default frequency. More importantly, we show that by assigning negative outlooks, credit rating agencies induce some issuers to exert recovery efforts to prevent subsequent downgrades. The findings support the theoretical prediction of Boot et al. (Rev Financ Stud 19(1):81–118, 2006) that credit rating actions serve as a coordination mechanism between rating agencies and issuers.
Original languageEnglish
JournalReview of Quantitative Finance and Accounting
DOIs
Publication statusE-pub ahead of print - 1 Jan 2020

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Bibliographical note

Poon acknowledges a research Grant (LU13501214) from the General Research Fund (GRF), Research Grants Council, Hong Kong. Poon and Shen acknowledge a Business Faculty Research Grant (DB14B2) from Lingnan University, Hong Kong, and a research Grant (UGC/FDS14/B20/16) from the Faculty Development Scheme (FDS), Research Grants Council, Hong Kong. Shen acknowledges a research Grant (P0030199) from the Hong Kong Polytechnic University. The authors thank Dorla Evans for her editorial work and Cheung Chun-Kit for his dependable research assistance.

Keywords

  • Credit risk
  • Information content
  • Rating outlook
  • Recovery effort

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