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Characteristics and Information Value of Credit Watches


  • The authors thank an anonymous referee for many valuable comments and suggestions. The authors also appreciate helpful comments and suggestions from Bill Christie (Editor), Alfred Liu, and workshop participants at the University of Connecticut, Hong Kong University of Science and Technology, Louisiana State University, University of North Texas, Seoul National University, Singapore Management University, and the American Accounting Association 2007 Annual Meeting. We also thank Marie Blouin, Hyun Jung Lee, Jung S. Shin, and Sean Yang for excellent research assistance. David Hamilton, Christopher Mann, Norm Stewart, and other staff at Moody's Investors Service provided invaluable information and assistance. Financial support from the University of North Texas and the State University of New York at Buffalo is gratefully acknowledged. The usual disclaimer applies.

*Kee H. Chung is the Louis M. Jacobs Professor of Financial Planning and Control in the School of Management at the State University of New York (SUNY) at Buffalo in Buffalo, New York. Carol Ann Frost is the Bernard Coda Professor of Accounting in the School of Business at the University of North Texas in Denton, TX. Myungsun Kim is an Associate Professor of Accounting in the School of Management at the State University of New York (SUNY) at Buffalo in Buffalo, New York.


We analyze credit watch and rating actions to better understand the role of credit watches in the credit rating process. We find that watch actions are more frequently prompted by specific, publicly known events than are rating actions. The likelihood that a watch action precedes a rating action varies systematically with proxies for investor demand for credit quality information and the adverse consequences of issuing a rating change prematurely. Credit watches occur more often in response to deterioration in credit quality, and issuers make concerted efforts to address the concerns that prompted down watches. Down watches are less likely than up watches to indicate the direction of the subsequent rating change. Watch announcements are associated with abnormal stock returns, indicating that credit watch actions are significant information events. Our results suggest that credit watches are informative and facilitate the stability of ratings by allowing firms to correct deficiencies and prevent downgrades.