Cross-Sectional Variation in Stock Price Reaction to Bond Rating Changes: Evidence from India (Empirical Results-6)

Intangible Assets based Portfolios – Panel E of Table 2 shows results of intangibles based portfolios. The nature of response to rating upgrades is different for high and low intangibility firms. In case of upgrades, while strong signal explains results for high intangibility firms, wealth redistribution dominates the firms with low intangibility. In case of firms with higher intangibles, the value of CAAR increases from 0.017 to 0.071 after upgrades. This is possibly because in these firms rating upgrades provide new earnings information. The abnormal returns continue from the pre – event period to the post -event period implying that the information is not fully absorbed in the first period. The CAAR becomes stronger after the announcement because the announcement possibly provides clear earnings signal for such companies which are usually difficult to value and have less predictable earnings. On the other hand, the wealth redistribution appears after the announcement which leads to negative returns in case of firms with small proportion of intangibles. This may be because earnings signal is not very strong as these companies are easier to value.
In case of downgrades both the portfolios demonstrate wealth redistribution effect after announcement. Moreover, after downgrades, the high intangible firms react strongly (CAAR = 0.056) in comparison to firms with low intangibles (CAAR = 0.048).
The firms with high component of intangibles show pre – emption about earnings signal both before upgrades and downgrades but the low intangibles firms exhibit surprise in case of upgrades.
Profitability based Portfolios- Panel F of Table 2 shows results of profitability based portfolios. Price response is more pronounced for small profitability firms compared to large profitability firms. The results for high profitability portfolio are insignificant. For low profitability firms, a response is seen both after upgrades and downgrades. Signalling effect is dominant after upgrades in low profitability firms. This may be because the investors normally do not expect firms with low profitability to be upgraded. The announcement of upgrade is seen as an improvement in the future earnings prospects of the firm. This leads to positive sentiment in the shareholders and generates significant returns. In case of downgrades, wealth redistribution effect dominates and overcomes the signal. Also firms with low profitability are likely to be downgraded, thus, anticipation is seen in form of significant pre – event returns. There is no pre – emption in case of upgrades. This may be because investors monitor negative market developments (leading to downgrades) more closely than good ones (which result in upgrades).

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