Review of Quantitative Finance and Accounting, 20: 49–62, 2003
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Are All Rivals Affected Equally by Bond
GARY L. CATON
Washington State University, 14204 NE Salmon Creek Avenue, Vancouver, WA 98686-9600
Tel.: 360-546-9516, Fax: 360-546-9037
Singapore Management University, Finance Department, Tanglin, PO Box 257, Singapore 912409
Tel.: +(65) 822 0254
Abstract. We use revisions in analysts’ earnings forecasts to examine how the bad news associated with a
bond rating downgrade gets transferred from the downgraded company to its rivals. In general, we ﬁnd that stock
analysts revise their earnings expectations downward for rivals of companies with downgraded debt. However,
the signiﬁcance of the revision is limited to rivals of downgraded companies with non-investment grade debt only.
For the rivals of companies with investment grade debt, we ﬁnd no signiﬁcant forecast revisions. We hypothesize
that this differential impact is due to differing levels of market visibility. This is consistent with our ﬁnding
that downgraded companies with non-investment grade debt are followed by signiﬁcantly fewer stock analysts.
Apparently not all rivals are affected equally by bond rating downgrades.
Keywords: bond ratings, intra-industry effects
JEL Classiﬁcation: G14
Bond rating agencies claim their ratings incorporate private information on the rated com-
panies that is unavailable to other market participants.
This information is obtained from
the rated companies themselves, presumably as part of the expected price of obtaining
a rating, and can include minutes of board meetings, proﬁt breakdowns by product, and
new product plans. Empirical ﬁndings support this claim by rating agencies. Wansley and
Clauretie (1985), Holthausen and Leftwich (1986), and Hand, Holthausen and Leftwich
(1992) all report negative excess stock returns following a downgrade of a company’s bond
rating. Examining the question of private information from a different angle, Ederington
and Goh (1998) argue that bond analysts and stock analysts provide similar services to
the investment community and in effect compete to provide the best analysis; one that
optimally combines the qualities of accuracy and timeliness. Obviously, access to private
information would tend to provide bond analysts with an advantage in this competition to