Cross-Sectional Variation in Stock Price Reaction to Bond Rating Changes: Evidence from India (Empirical Results-8)

Firm characteristic based portfolios
The results of relationship of post -event stock returns with pre – event stock returns, magnitude of rating change and business cycle in case of bond rating changes for firm characteristic based portfolios are shown in Table 4. Significant relationship was observed in only two cases. The portfolios based on liquidity cross – sectional variation in case of upgrades. The relationship between pre – event and post – event returns was found to be significant in case of upgrades for portfolios with large trading volume. This may be because in case of firms with high liquidity of stocks, more information in the form of voluntary disclosures and transparency is expected. Thus, the market is able to anticipate the rating change in advance and starts responding to this information even before actual announcement. The relationship was positive indicating importance of the information being conveyed through the upgrade.
The second case where the firm characteristic based portfolio showed significant results was in case of upgrades of portfolio with small proportion of intangibles. Here, a significant positive relationship was observed between business cycle and post – event returns. This implies that during a downward trend in business cycle, the firms with small proportion of intangibles give better returns after upgrade. It may be because these companies have more tangible assets whose value does not erode when the business cycle takes a downturn. Further, the investors may shift from companies which have more intangibles as the value of these intangible assets gets eroded during adverse conditions making such investments more risky. Thus, the firms with small proportion of intangibles become more attractive. Moreover, during adverse economic conditions investors expect ratings to be downgraded whereas upgrades are less common. As a result, the investors respond more strongly to an upgrade than a downgrade (which is a common occurrence during such periods).
In all other cases no significant relationship was observed between the post – event abnormal returns and independent variables. This implies that these variables do not explain cross sectional variation for the characteristic based portfolios except in the two cases mentioned above.

Table 4. Results of Regression Between Post – event CAR and Pre – event CAR, Magnitude of Rating Change, Business Cycle Dummy for Bond Rating Changes of Characteristic – based Portfolios

Panel A: Results for Size – Based Portfolios
Downgrades Upgrades
Large Small Large Small**
Beta t Beta t Beta t Beta t
Constant 0.254 2.191 0.001 0.013 0.220 1.070 0.036 0.294
CARi -0.523 -2.258 0.510 0.867 0.962 1.266 0.729 1.180
NUM GRADE -0.143 -1.607 0.030 0.681 -0.174 -1.053
BUSINESS CYCLE 0.139 1.166 -0.028 -0.285 -0.027 -0.291 -0.004 -0.031
Adjusted R Square 0.605 0.077 0.112 0.256
Panel B: Results for Price to Book Value – Based Portfolios
Downgrades Upgrades
High*** Low High Low
Beta t Beta t Beta t Beta t
Constant -0.966 0.033 0.443 0.232 2.117 0.215 0.804
CARi -3.360 -0.285 -1.025 0.737 1.704 1.106 1.401
NUM GRADE 0.139 -0.005 -0.149 -0.187 -1.950 -0.157 -0.659
BUSINESS CYCLE 0.678 0.088 1.291 -0.082 -1.569 -0.029 -0.157
Adjusted R Square 0.136 0.046 0.173
Panel C : Results for Stock Liquidity – Based Portfolios
Downgrades Upgrades
High Low High Low
Beta t Beta t Beta t Beta t
Constant -0.047 -0.432 0.118 0.894 0.171 1.445 0.229 0.712
CARi -0.340 -1.353 0.505 0.674 0.733* 2.304 0.773 0.926
NUM GRADE 0.009 0.142 0.025 0.451 -0.157 -1.647 -0.151 -0.587
BUSINESS CYCLE 0.160 2.040 -0.114 -0.796 -0.071 -1.573 -0.019 -0.135
Adjusted R Square 0.425 0.098 0.456 0.101
Panel D: Results for Leverage – Based Portfolios
Downgrades Upgrades
High Low High Low**
Beta t Beta t Beta t Beta t
Constant 0.086 1.247 -0.119 -0.754 0.192 1.320 0.052 0.405
CARi -0.605 -2.067 -0.807 -1.120 0.756 2.161 0.770 0.686
Num_grade -0.040 -1.283 0.541 1.412 -0.169 -1.522
BUSINESS CYCLE 0.140 1.857 0.184 0.916 -0.062 -1.094 0.011 0.077
Adjusted R Square 0.444 0.601 0.405 0.045
Panel E: Results for Intangibles – Based Portfolios
Downgrades Upgrades
High Low High** Low
Beta t Beta t Beta t Beta t
Constant 0.013 0.099 0.040 0.158 0.038 0.471 0.005 0.114
CARi -0.410 -0.560 -0.660 -1.582 0.366 0.371 0.372 1.648
NUM GRADE -0.009 -0.170 0.005 0.025 -0.038 -0.965
BUSINESS CYCLE 0.079 0.609 0.082 0.635 0.053 0.443 0.132* 2.304
Adjusted R Square 0.106 0.476 0.038 0.808
Panel F: Results for Profitability – Based Portfolios
Downgrades Upgrades
High Low High Low
Beta t Beta t Beta t Beta t
Constant 0.013 0.404 0.08 0.721 0.132 0.914 0.339 0.576
CARi -0.238 -4.371 -0.622 -1.492 0.565 1.679 2.059 0.926
NUM GRADE -0.020 -1.102 -0.023 -0.509 -0.128 -1.055 -0.258 -0.594
BUSINESS CYCLE 0.016 0.852 0.063 0.587 -0.019 -0.355 0.059 0.214
Adjusted R Square 0.956 0.209 0.168 0.277

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