The Credit Rating of Companies Considering Management Factors

Document Type : Research Paper

Authors

1 Ph.D. Candidate in Accounting, Rasht Branch, Islamic Azad University, Rasht, Iran.

2 Assistant Professor of Accounting, Rasht Branch, Islamic Azad University, Rasht, Iran.

10.22103/jak.2024.22564.3992

Abstract

Objective: Credit rating agencies play an important role in monitoring and disseminating information, and their ability to reduce information asymmetry means they have a unique role in creating value for debt and equity holders. The credit rating is an index that indicates the credit risk (default risk) of a company (debtor) or a specific debt (corporate bonds) and is a measure for determining the costs (interest rate) incurred when using other people's capital in the market; As an important indicator when issuing corporate bonds or borrowing funds, it affects the cash flow and value of the company. A credit rating is important to a company because of its impact on the valuation of stocks and bonds and the legal and contractual costs (benefits) associated with a change in credit rating. Therefore, managers are incentivized to maintain or achieve a favorable credit rating by influencing the rating agencies' perception of the firm's creditworthiness. The existing literature shows that the costs (benefits) associated with credit rating changes affect managerial capital structure decisions and firm financing choices, and firms tend to adjust leverage to influence rating agencies' decisions. However, leverage is not the only important consideration for rating agencies when determining a company's credit rating. On the other hand, the rating process requires analyzing publicly disclosed company information about a company's value. This study investigates how to use management and performance (managers' discretionary disclosure, managers' ability and accounting conservatism) to achieve a favorable credit rating.
Method: The data of 90 companies admitted to the Iran Stock Exchange during the years 2013 to 2023 and a total of 990 annual financial statement reports, explanatory notes and reports of the board of directors' activities to the annual meeting of shareholders were used. Multiple regression methods have used hypotheses based on combined data.
This checklist consists of 60 components for optional disclosure that each item in the checklist if it is disclosed in the annual financial statements, explanatory notes and the report of the general meeting; The number is considered to be one and otherwise zero, and finally, the optional disclosure index is calculated by dividing the sum of disclosed items by the total items that should be disclosed.
Findings The results of the first hypothesis test showed that companies get higher ranks with the increase in managers' discretionary disclosure. It seems that companies tend to commit to the disclosure of credible information to influence the perception of rating agencies. A credible commitment to voluntary disclosure reduces the information asymmetry between inside and outside the firm, resulting in rating agencies' expectations of higher creditworthiness of the firm. Managers appear to use discretionary disclosure to obtain favorable ratings rationally.
Conclusion: The increase in managers' voluntary disclosure may be due to opportunistic motives to obtain a favorable credit rating. An increase in conservatism will lead to a decrease in the manager's opportunistic behavior and a decrease in default risk. Therefore, companies with higher levels of conservatism and higher credit ratings are rewarded with lower debt costs. Rating agencies are likely to consider managers' ability as a signal of lower default risk, given the tendency of managers with higher ability to deliver more limited performance results in the future. By increasing managers' discretionary disclosure, companies get higher ratings. It seems that companies tend to commit to the disclosure of credible information to influence the perception of rating agencies. A credible commitment to voluntary disclosure reduces the information asymmetry between inside and outside the firm, resulting in rating agencies' expectations of higher creditworthiness of the firm. Managers appear to use discretionary disclosure to obtain favorable ratings rationally. Since a significant positive relationship exists between credit rating and discretionary disclosure, companies may have incentives for opportunistic disclosure to obtain a favorable credit rating. The results of this research are consistent with the results of Kim and Ahn (2023) and Hee (2018). Since managers with high ability improve firm performance and information transparency, the idea that managers' ability positively affect credit rating is intuitive. However, it is unclear whether credit rating agencies can accurately measure managers' ability and consider it an independent risk factor because the assessment of managerial ability is subjective and difficult to separate from company performance. The results of the second hypothesis test show a positive and significant relationship between managers' ability and credit rating; companies with more capable managers are more likely to get a higher credit rating. This shows that credit rating agencies recognize managers' ability as an independent credit factor. Hence, rating agencies are likely to consider managers' ability as a signal of lower default risk, given the tendency of managers with higher ability to deliver more limited performance results in the future.
Conservative reporting reduces information asymmetry between debt holders and managers, bondholder and shareholder conflicts, debt costs, and default probability. Therefore, it is considered an important accounting method that validates financial reporting. Therefore, managers can use conservative accounting to influence the credit rating analyst's perception of default risk. The results of the third hypothesis show that conservatism positively and significantly affects credit rating. This result shows that companies with higher conservatism get a higher credit rating. It seems that a company that practices more accounting conservatism reduces default risk by increasing cash holdings, and a company that increases accounting conservatism reduces default risk and agency conflict by increasing efficient investments. Hence, credit markets react to corporate reporting strategies and issue higher credit ratings to companies with lower default risk.

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Main Subjects

References

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  • Receive Date: 25 November 2023
  • Revise Date: 06 June 2024
  • Accept Date: 19 June 2024

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