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Credit Ratings and Capital Structure



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    • Department of Finance at Boston College. This paper is derived from my doctoral dissertation in finance completed at the School of Business, University of Washington. The paper has substantially benefited from the input and advice of my advisor, Edward Rice. I also gratefully acknowledge the comments received from Wayne Ferson, Charles Hadlock, Jonathan Karpoff, Jennifer Koski, Paul Malatesta, Mitchell Peterson, an anonymous referee, and seminar participants at the 2004 American Finance Association meetings, Boston College, Indiana University, Northwestern University, Rice University, University of Pittsburgh, University of Virginia, University of Washington, West Virginia University, and Xavier University.


This paper examines to what extent credit ratings directly affect capital structure decisions. The paper outlines discrete costs (benefits) associated with firm credit rating level differences and tests whether concerns for these costs (benefits) directly affect debt and equity financing decisions. Firms near a credit rating upgrade or downgrade issue less debt relative to equity than firms not near a change in rating. This behavior is consistent with discrete costs (benefits) of rating changes but is not explained by traditional capital structure theories. The results persist within previous empirical tests of the pecking order and tradeoff capital structure theories.