We analyze credit watch and rating actions to better understand the role of credit watches in the credit rating process.
Credit rating agencies (CRAs) issue credit watches to indicate the potential direction of a rating change that might follow the resolution of specific events or trends.
Our analysis of credit watches is motivated by their importance in the credit rating process, and many issues on the value of credit ratings resulting from apparent failures in the credit rating process.
We investigate whether credit watches are used in a manner consistent with the dual role of CRAs as both providers of information and suppliers of ratings that are sufficiently stable and reliable to be used in contracting.
(2006), we find that credit watches occur more often in response to a deterioration in credit quality.
(2006) view that credit watches can be viewed as an implicit contracts between the issuer and the CRA where the issuer agrees to take the actions necessary to avoid the reduction of its credit rating.
This qualitative information, along with quantitative data (as used in most prior research), allows us to conduct more powerful analyses of watch actions and the information content of credit watches.
Section I discusses the role of credit watches. Section II presents data and descriptive statistics.
(9) CRAs state that credit watches are triggered by: 1) discrete events such as mergers, acquisitions, restructuring, and company announcements of plans expected to affect credit quality and/or 2) trends in the issuer's operations or financial strength, in its industry or regulatory environment, or in the macroeconomic climate of its country or region of operations (Keenan, Fons, and Carty, 1998; FitchRatings, 2007).
As discussed below, we hypothesize that credit watches, like credit ratings, support CRAs' roles of supplying value-relevant information and facilitating contracting (through promoting ratings stability) in the capital markets.
Holthausen and Leftwich (1986) and Hand, Holthausen, and Leftwich (1992) provide early evidence on the information-supplying role of credit watches. The sample period in both studies is the first 26 months that Standard and Poor's (S&P) issued credit watches.