DO CREDIT RATING AGENCIES’ ADJUSTED FINANCIAL RATIOS ALWAYS SURPASS UNADJUSTED RATIOS IN EXPLAINING CREDIT RATINGS? AN INTERNATIONAL ANALYSIS

Abstract

With the growing importance of global Credit Ratings Agencies (CRAs) in the modern financial world, it is imperative that we seek a thorough understanding of the credit ratings process. Through this study, I investigate the extent to which quantitative adjustments undertaken by CRAs are incrementally useful in explaining credit ratings and whether the extent of this incremental usefulness varies across countries. In doing so, I seek to ascertain if such adjustments perform a valued-added role in formulating credit ratings decisions; or if they are included as a mere perfunctory measure. Using a sample of firms from Standard & Poor’s Ratings Direct database, I find that post-adjustment financial ratios that incorporate analytical adjustments do, on average, incrementally improve on unadjusted ratios (reported numbers from financial statements), in explaining credit ratings. However, adjusted ratios do not always surpass unadjusted ratios at all times and the incremental usefulness of these adjustments varies across different institutional factors. Specifically, I observe that this incremental usefulness is greater in countries with higher corporate disclosure transparency and lower value relevance of accounting information. Yet, in further analyses, I find that legal origins and IFRS adoption do not exert an influence on the usefulness of adjustments. These findings offer a greater understanding of how analyst adjustments take on varying levels of usefulness in the credit ratings process, depending on the institutional settings in which the issuer is immersed.