Bankruptcy Probability Changes and the Differential Informativeness of Bond Upgrades and Downgrades

Posted: 6 Feb 2007

See all articles by Yongtae Kim

Yongtae Kim

Santa Clara University - Leavey School of Business

Sandeep Nabar

Oklahoma State University, Stillwater - Spears School of Business

Abstract

Prior studies have found that stock returns around announcements of bond upgrades are insignificant, but that stock prices respond negatively to announcements of bond downgrades. This asymmetric stock market reaction suggests either that bond downgrades are timelier than upgrades, or that voluntary disclosures by managers preempt upgrades but not downgrades. This study investigates these conjectures by examining changes in firms' probabilities of bankruptcy (assessed using bankruptcy prediction models) and voluntary disclosure activity around rating change announcements. The results indicate that the assessed probability of bankruptcy decreases before bond upgrades, but not after. By contrast, the assessed probability of bankruptcy increases both before and after bond downgrades. We also find that controlling for potential wealth-transfer related rating actions, which can impact stock returns differently, does not alter our results. Tests of press releases and earnings forecasts issued by firms suggest that the differential informativeness of upgrades and downgrades is not caused by differences in pre-rating change voluntary disclosures by upgraded and downgraded firms. The results support the hypothesis that downgrades are timelier than upgrades.

Keywords: Bond rating, Bankruptcy probability, Default risk, Voluntary disclosure

JEL Classification: G30, G33, M41

Suggested Citation

Kim, Yongtae and Nabar, Sandeep, Bankruptcy Probability Changes and the Differential Informativeness of Bond Upgrades and Downgrades. Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=960751

Yongtae Kim (Contact Author)

Santa Clara University - Leavey School of Business ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States
(408) 554-4667 (Phone)
(408) 554-2331 (Fax)

Sandeep Nabar

Oklahoma State University, Stillwater - Spears School of Business ( email )

456 Spears School of Business
Stillwater, OK 74078-1680
United States

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