Credit Rating and Cost of Capital

Document Type : Research Paper

Authors

1 Prof., Department of Accounting, Faculty of Social Sciences and Economics, Alzahra University, Tehran, Iran.

2 Assistant Prof., Department of Accounting, Faculty of Social Sciences and Economics, Alzahra University, Tehran, Iran.

3 Ph.D. Candidate, Department of Accounting, Faculty of Social Sciences and Economics, Alzahra University, Tehran, Iran.

10.22059/frj.2022.342131.1007325

Abstract

Objective: The competitive business environment is growing, accordingly, companies are forced to compete with various national and international factors and expand their activities through their new investments. To make these investments, they need financial resources. The importance of accessing useful information for decision-making is important, as it is considered an investor right. Credit rating is useful information for investment decision-making. This study examines the relationship between credit rating and the cost of capital. Its purpose is to examine whether an increase in credit rating leads to an increase in the cost of equity and a decrease in debt costs or not. Because of the narrow background of ranking institutions in Iran and the reluctance of the companies toward the ranking system, a general ranking model is commonly used to determine the rank of the investigated companies.
Methods: This study examines a sample of 142 companies listed on the Tehran stock exchange from 2014 to 2020. The companies were selected through a systematic elimination process. The credit rating for each company was measured using the Emerging Market Credit Scoring Model. This rating was then adjusted in three steps: (1) considering the company's vulnerability to exchange rate fluctuations, (2) assessing the degree of credit rating of the industry, and (3) evaluating the company's competitiveness within the industry. A dummy variable was used to indicate an increase or decrease in credit rating from the previous year, where an increase takes the value of one and a decrease takes the value of zero. The cost of debt was calculated by dividing the interest expense in year t+1 by the average debt during years t and t+1, while the cost of equity was calculated by dividing net profits by the equity market value in year t. We used multiple regression with the Generalized Least Squares (GLS) method.
Results: According to the obtained results, there is a positive relationship between credit ratings and equity costs, and any increase in credit ratings can reduce the costs of debts.
Conclusion: Based on the achieved results, there appears to be a positive correlation between credit ratings and the cost of equity. Furthermore, any increase in credit ratings has the potential to decrease the cost of debt. As a result, an increase in credit rating may lead to an increase in profits, because debt costs decrease and equity costs are affected. This subsequently influences investment decisions. Additionally, the risk of a company can have an impact on its expected rate of return. These findings align with Chen, Chen, Chang, & Yang (2013) as well as Kissgen and Esrahan (2010). It is worth noting that the Emerging Market Model has been validated by comparing its rankings to those announced by the rating agencies. This model takes into account both quantitative and qualitative factors. Therefore, we suggest that rating agencies consider utilizing these results as a guideline for ranking purposes.

Keywords

Main Subjects

References

Almeida, H., Cunha, I., Ferreira, M. A. & Restrepo, F. (2017). The real effects of credit ratings: The sovereign ceiling channel. The Journal of Finance, 72(1), 249-290.
Altman, Edward I. & Hotchkiss, E. (2005). Corporate Financial Distress and Bankruptcy: Predict and Avoid Bankruptcy, Analyze and Invest in Distressed Debt. (3th ed.). New York: John Wiley and Sons.
Ashbaugh-Skaife, H., Collins, D. W. & LaFond, R. (2006). The effects of corporate governance on firms’ credit ratings. Journal of accounting and economics, 42(1-2), 203-243.‏
Bales, K. & Malikane, C. (2020). The effect of credit ratings on emerging market volatility. Journal of International Financial Markets, Institutions and Money, 65, 101186.
Basu, R., Naughton, J. P., & Wang, C. (2017). The effect of credit rating changes on voluntary disclosure. Social Science Electronic Publishing.
Chen, S. S., Chen, H. Y., Chang, C. C., & Yang, S. L. (2013). How do sovereign credit rating changes affect private investment? Journal of Banking & Finance, 37(12), 4820-4833.‌
Falahpor, S. & Qahramani, A. (2021). Introduce and examine the characteristics of centrality as a new criterion for network analysis, risk assessment and stock portfolio selection. Financial Research, 23 (2), 158-171. (in Persian)
Gillette, J. R., Samuels, D. & Zhou, F. S. (2020). The effect of credit ratings on disclosure: Evidence from the recalibration of Moody's municipal ratings. Journal of Accounting Research, 58(3), 693-739.‌
Hosienpoor Bahabadi, D. (2006). Survey the relationship between Capital Structure Changes and Change in the Firms Value in Accepted Companies in Tehran Stock Exchange. A Thesis for Degree of M.A. Accounting University of Tehran. (in Persian)
Jafari, S. M. & Ahmadvand, M. (2015). The credit rating of companies listed at Tehran stock exchange using the emerging market scoring model. Economic and business bulletin of the business, 6(10), 56-37. (in Persian)
Khajavi, sh. & momtazian, A. (2014). Investigating the effect of quality of financial information disclosure on current and future stock returns. Financial Accounting Knowledge, 1(1), 9-27. (in Persian)
Kisgen, D. J. & Strahan, P. E. (2010). Do regulations based on credit ratings affect a firm's cost of capital?. The Review of Financial Studies, 23(12), 4324-4347.‌
Lin, Y.M., Shen, C.A. (2015). Family firms' credit rating, idiosyncratic risk, and earnings management. Journal of Business Research, 68(4), 872-877.
Mahmoudabadi, H. & Ghayouri Moghaddam, A. (2011). Credit Rating in terms of Financial Ability to Pay Principle and Interest Debt by using Data Envelopment Analysis Thechniques (Case Study: Companies Listed in Tehran Stock Exchange). Journal of Accounting Knowledge, 2 (4), 125-145. (in Persian)
Mashayekh, Sh. & Shahrokhi, S. S. (2016). Identify the indicators that determine the credit rating of companies. Investment Knowledge, 5 (19), 25-52. (in Persian)
Mehrani, S. & Cream, Gh. (2017). Accounting Theory. Volume Second, Tehran, Publications Negah Danesh. (in Persian)
Mohammadi Khaneghah, G., Piri, P. & Mansourfar, Gh. (2020). Real profit management, quality of corporate governance and credit rating. Accounting and Auditing Reviews, 26 (4), 595-614. (in Persian)
MurciaI, F. C. D. S. & Dal-Ri Murcia, F. & Rover, S. & Borba, J. A. (2014). The determinants of credit rating: Brazilian evidence. BAR-Brazilian Administration Review, 11(2), 188-209.‌
Rasaeian, A. & Hosseini, V. (2008). Relationship between the quality of accruals and the cost of capital in Iran. Accounting and Auditing Reviews, 15(53), 67-82. (in Persian)
Rashidi, M. (2021). Impact of operational diversification and investment opportunities on the relationship between capital fee and change CEO, Financial Research, 22(3), 450-428. (in Persian)
Realdon, M. (2013). Credit risk, valuation and fundamental analysis. International Review of Financial Analysis, 27, 77-90.‏
Reinhart, C.M. (2002). Default currency crises, and sovereign credit ratings. Worldbank Economic Review, 16, 151–170.
Rostami, W. & Rezaei. L. (2019). The effect of proper disclosure and information quality rating on debt capacity. Knowledge of Financial Accounting, 6 (1), 107-136. (in Persian)
Taghahvi, S.A & Golbaz, L. (2017). Consider the effect of the credit companies on the Stock Exchange price of the stock market, scientific Information Database. Financial Management Strategy, 4(1), 141-167. doi: 10.22051/jfm.2016.2379 (in Persian)
Financial Research Journal
Volume 25, Issue 1
2023
Pages 110-126

Files

Share

How to cite

Statistics