The impact of credit ratings on firms’ capital structure decisions – A study on the European market

Abstract: The aim of this study is to empirically investigate the impact of credit ratings on European firms’ capital structure decisions based on the premise of Darren Kisgen’s Credit Ratings–Capital Structure (CR-CS) hypothesis: that firms face discrete costs (benefits) associated with differences in credit rating levels. This project's empirical investigations are based on historical data from Standard & Poor's long-term issuer rating and firm financials on a sample of 169 firms. The data collected covers a 10-year period, amounting to a total of 1,464 firm-years (1,374 excluding missing values for commonly used variables). The findings of this study support the hypothesis of credit ratings as a determinant in firms’ choice of capital structure. We find that concerns of discrete costs associated with changes in credit ratings result in adjustments being made to capital structure: firms near a change in Broad Rating and investment-grade/speculative-grade status issue 0.97% and 1.60% less debt relative to equity, respectively, than firms not near a change. This behaviour does not appear to be explained by the trade-off and pecking order theories. This study also expands the empirical scope on this topic. Previous investigations have largely been limited to the US (and to some extent, international) market, whilst this study investigates the CR-CS hypothesis on a European sample. Moreover, the analytical structure of this study further refines and strengthens the analytical basis of the hypothesis.