INFORMATION VALUE OF S&P CREDIT REPORTS: THE ROLE OF TONES

Abstract

This paper studies the information value of tones in S&P’s credit rating reports by employing computerized textual analysis technique in Loughran and McDonald (2011). We find that both negative and positive tones in the reports significantly affect stock returns when firms are downgraded whereas the downgrade action itself is no longer a significant explanatory variable anymore. The negative tones also matter for credit watch and credit outlook changes. The information value of the tones is mainly concentrated on firms with investment grade rather than those with speculative grade. We also find that positive tones can significantly reduce the probability of future downgrade. Robustness tests show that computer-coded tones perform as well as the tones coded by humans in explaining the return reactions. Moreover, we find that extremely uncertain tones can reduce the positive stock reactions towards upgrade. An alternative measure of information uncertainty in the reports shows that extremely uncertain tones can reduce the positive stock reactions towards developing credit watch as well. Overall, our study reveals that the tones in credit news announcements are at least as important as credit actions themselves.