Table 6.6 illustrates the capital structures of the firms with respect to their credit ratings. Panel A of Table 6.6 shows the average debt ratios with respect to credit ratings coded 1 to 6 and Panel B shows the average debt ratios with respect to credit ratings codes 1-16. Panel A shows that firms with the highest credit ratings have lower average debt ratios while the change in mean debt ratio between each broad rating category is close to 9 percentage points, on average. For example, from AA to A, the difference in the average debt ratio is 9 percentage points and then continues to increase by 7 and 10 percentage points until the B category. After broad rating category B, the average ratio starts declining. Also to note, the standard deviation of the debt ratio for top rated firms is very low, suggesting that such firms attempt to keep the amount of leverage not only low but also close to other firms in
136 the market having higher ratings. As the credit ratings decline, the debt ratio gradually starts increasing. At the same time, the standard deviation and coefficient of variation start increasing, implying that low rated firms and non-rated firms have more dispersion between themselves with respect to capital structure, compared to high rated firms.
Table 6.6
Alternative Credit Ratings codes and Debt Ratios Panel A: Broad Credit Ratings Categories and Debt Ratios
CR Codes 1-6 Mean Median Std. Dev
AA 1 0.21 0.23 0.08 A 2 0.30 0.28 0.13 BBB 3 0.37 0.35 0.15 BB 4 0.47 0.49 0.24 B 5 0.43 0.44 0.20 NR 6 0.20 0.17 0.17
Panel B: Individual Credit ratings and Debt Ratios
CR Codes 1-16 Mean Median Std. Dev
AA+ 1 0.10 0.10 0.06 AA 2 0.23 0.24 0.06 AA- 3 0.24 0.25 0.07 A+ 4 0.27 0.27 0.11 A 5 0.30 0.29 0.14 A- 6 0.32 0.30 0.14 BBB+ 7 0.33 0.31 0.15 BBB 8 0.39 0.37 0.14 BBB- 9 0.38 0.37 0.18 BB+ 10 0.46 0.48 0.22 BB 11 0.42 0.39 0.26 BB- 12 0.51 0.51 0.23 B+ 13 0.56 0.64 0.20 B 14 0.33 0.36 0.14 B- 15 0.39 0.42 0.20 NR 16 0.20 0.17 0.17 Notes: This table displays the descriptive statistics for the dependent variable (total debt by total assets) with respect to the broad rating categories (1-6) and individual ratings (1-16) where the last code in both the scales is assigned to the non-rated firms.
A similar pattern can be noted for individual credit ratings. Panel B of Table 6.6 indicates that the average debt ratio is lower for the top rated firms and increases as the rating declines. Firms with B+ rating have the highest debt ratios at an average of 0.56 whereas the firms with AA+ have the lowest debt ratio at 0.10. In some broad rating categories firms with a‘+’ sign appear to have lower leverage than other ratings i.e., AA, A and BBB categories, but this trend is not consistent. Similarly, for some ratings categories, the mean debt ratio is also lower when the firms have a ‘-’ sign with their credit rating, although it is less common. This does not provide any clear evidence whether firms have lower leverage when they are near upgrades and downgrades. Formal analysis in the next chapter will
137
Individual Credit Ratings
Figure 6.2 (b): Individual Credit Ratings and Average Debt Ratios
Broad Credit Ratings
Figure 6.2 (a): Broad Credit Ratings and Average Debt Ratios
further explore the relationship and the discussion on the possible reverse causation is postponed until then.
Figure 6.2 (a) and (b) presents a graphical representation of debt ratios with respect to broad and individual credit ratings and Figure 6.3 presents the average debt ratios of the UK firms with respect to credit ratings over the sample period.
138 All three figures show a clear non-linear pattern of average debt ratios with respect to the credit ratings. As can be observed, non-rated firms have the lowest level of gearing compared to all broad rating categories which indicates that such firms have lesser access to debt markets compared to rated firms, whether investment grade or speculative grade firms. This supports Lemmon and Zender (2010) who find that the rated firms, irrespective of their ratings, have higher debt capacity compared to the non-rated firms. On the other hand, the top rated firms have an extremely low level of leverage, which indicates other motives of top rated firms for acquiring credit ratings, besides accessing debt markets. Further discussion is postponed until Section 6.2.
Figure 6.3 shows that the debt ratio of the non-rated firms remain on average around 0.20 in almost all the years, whereas the firms with credit ratings do not just change over years, but also with each ratings category. However, the figures have to be interpreted with caution, as the rated firm-years are relatively fewer than non-rated firm-years, which affect the average debt ratio of both the groups. A slight non-linearity can be observed in the debt ratio with reference to the credit ratings, irrespective of the years or the inclusion of non- rated firms. Moreover, the rated firms also show higher leverage at the start of the sample period which over the years has a decreasing trend. It is likely that during the initial few years of rating services in the UK market, newly rated firms widely accessed the debt market resulting in higher gearing ratios. However, the decreasing trend in the debt ratios
139 suggests that firms had to maintain relatively conservative debt ratios in order to maintain their current ratings status or achieve higher ratings as per the threshold of the rating agencies. Prior evidence from the US and UK market suggests that rating agencies over the
period have become stringent (Blume et al., 1998; Gonis and Taylor, 2009). Gonis and
Taylor (2009) also document that UK firms’ credit quality has also deteriorated over the past few years. This might be another reason for the decreasing trend in the debt ratios.