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Have Rating Agencies Become More Conservative Implications for Capital Structure and Debt Pricing - Book Report/Review Example

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This refers to a person or a companys ability to pay back a loan timely or their likelihood of default payment. These agencies can also be involved in the rating of the creditworthiness of loaners of…
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Have Rating Agencies Become More Conservative Implications for Capital Structure and Debt Pricing
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Download file to see previous pages This is notably in the assignment of corporate credit rating between the years 1985 and 2009. This conservatism has seen the average debt ratings drop by three notches over this period. However, these changes in credit rating have not produced the anticipated implications for many firms. The affected had adopted a policy of holding more cash and issuing less debt.
The events that led to the financial crisis in 2008 were linked by observers to have been partly caused by rating agencies due to their failure in rating the creditworthiness of individuals as well as institutions. These observers accused the rating agencies of having been too generous with endorsing institutions to borrow high valued securities despite the associated high default risk. Following the financial crisis, these companies have been subjected to increased scrutiny to avoid such a scenario from repeating itself.
As such, several changes have been made in the standards applied by rating agencies that have had a significant impact of companies debt pricing policies. These changes have been as a result of the direct blame to rating agencies for the 2008 economic crisis. The conservatisms of rating agencies, first documented by Blume and MacKinlay, has shown that the latter increased conservatisms. For instance, a firm rated AAA in terms of credit worthiness back in the year 1985 could only be rated AA in the year 2009 when the standards of rating agencies were reviewed. Astonishingly, firms with BBB rating by 1985 have been seen to lose their creditworthiness by recent times.
The implications of this increased conservatism can be viewed in two dimensions. First, if the increased stringency applied by these agencies occurred when the latter was warranted given the changes in the macroeconomic environment and their effects on general default risk, then there would be no observable change in default risk as seen between the years 1985 and ...Download file to see next pagesRead More
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