The impact of credit ratings on firms’ capital structure decisions

Abstract

This paper analyses empirical evidence on credit ratings being determining factors for making capital structure decisions. In particular, the relationship between changes in credit ratings and changes in capital structure ratios is investigated. The study’s review of literature includes previous works which conducted studies on credit ratings and capital structure in addition to prominent capital structure theories. The methodological approach undertaken in this dissertation was of a deductive and quantitative nature. Correlation testing was used to identify relationships, together with their significance, between credit ratings and capital structure ratios, such as interest coverage, financial leverage and debt-equity ratio. The empirical investigations were conducted using historical credit ratings assigned by Moody’s and leverage ratios of 131 companies (71 of which were omitted), making up the whole retail Industry in the S&P 500 Index. The data collection covered the 5 year-period from 2012-2016, being the most recently available data encompassing similar-to- current market conditions. The findings of this study were not fully capable of identifying a significant correlation between credit ratings and the three leverage ratios representing capital structure. Nevertheless, an alternative argument was proposed, supporting the hypothesis that credit ratings and capital structure are related to each other.