Asian Review of Financial Research

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A Study on the Effect of Credit Ratings on M&A Activity ×
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Asian Review of Financial Research Vol.33 No.3 pp.339-375
A Study on the Effect of Credit Ratings on M&A Activity
Seonhyeon Kim1†
1 고려대학교 경영대학 박사과정
Changki kim1†
1 고려대학교 경영대학 교수
Key Words : 신용등급; M&A; 재무제약; 재무곤경; 정보 비대칭;Credit rating; M&A; Financial constraint; Financial distress; Information asymmetry

Abstract

Credit rating agencies give firms credit ratings to indicate their creditworthiness. As these agencies have sophisticated methodologies for evaluating managerial, affiliate, industry, business, and financial risks, they play an important role in the financial market. In addition, credit rating agencies play the monitoring role of managers and mitigate information asymmetry problems (Fulghieri et al., 2014; Surendranath et al., 2016) in the debt market by producing and delivering information. Many studies argue that credit ratings are related to firms' financial constraints and/or ability to access the debt market (Faulkender and Petersen, 2006; Campello et al., 2010; Karampatsas et al., 2014). There is evidence that credit ratings affect the investment activities of domestic firms (Kim and Shin, 2017). For example, credit ratings may affect corporate mergers and acquisitions (M&A), which are complex processes reflecting relatively large corporate investment decisions. However, there is little research on the influence of credit ratings on M&A activities in Korea, despite studies of this topic in other countries (Harford and Uysal, 2014; Karampatsas et al., 2014, Aktas et al., 2018). If credit rating agencies deliver information through credit ratings (Fulgieri et al., 2014, Surrendranath et al., 2016), companies that have received credit ratings (i.e., rated firms) will have fewer information asymmetry problems than those that have not. Boeh (2011) states that mitigating information asymmetry reduces the transaction and contract costs associated with M&A. As information asymmetry in the domestic stock market is a risk factor that increases the required return (Choe and Yang, 2007), credit ratings affect M&A activities. Therefore, rated firms are more likely to participate in M&A than non-rated firms are. A firm's credit rating level represents its financial constraints (Faulkender and Petersen, 2006; Campello et al., 2010; Karampatsas et al., 2014). As M&A increase the risk of bank-ruptcy (Bessembinder et al., 2009; Furfine and Rosen, 2011), companies with low credit ratings are highly likely to avoid acquiring other firms. Therefore, firms with high credit ratings are more likely to be bidders in M&A transactions than are firms with low credit ratings. However, M&A transactions can also efficiently relocate the assets of bankrupt firms (Hotchkiss and Mooradian, 1998). As financially distressed firms have a motive to sell their assets (Weitzel and Jonsson, 1989), they are more likely to sell their assets than non-distressed firms are. Therefore, this study argues that firms with low credit ratings are more likely to be M&A targets s than firms with high credit ratings are. This study yields three main findings. First, rated firms are more likely to participate in M&A than non-rated firms are, whether as bidders or as targets. This finding is more pronounced when firms face information asymmetry problems. We measure information asymmetry by the number of analysts and the competitiveness of the product market. When the number of analysts is zero (vs. one or more) or the market is non-competitive (vs. competitive), rated firms are more likely to be bidders (or targets). Therefore, a firm's credit rating affects its M&A activities through the benefit of information. In addition, the benefit of reduced information asymmetry available to rated firms affects the market reaction when acquirers announce their M&A projects. Second, we find that a firm's rating level affects its probability of being a target of M&A. Firms with very low credit ratings face particularly high levels of default risk and financial distress. When a firm is financially constrained or experiencing bad sales, or when a global financial crisis is underway, the negative effect of credit rating level on the firmatiprobability of being a target is more pronounced. Under the same circumstances, the effect of credit rating level on a firm's probability of being a bidder is also negative. These findings reject our hypothesis that a firm that is better able to conduct capital financing is more likely to be an acquirer. Third, we find that credit rating level and biddersrating level and r. is moreore pronouninverted U-shaped relationship. Our results suggest that firms with very low credit ratings are undervalued by investors in in terms of M&A projectswith very low credit ratings they have a high required or expected rate of return. In addition, managers of firms with very high credit ratings are likely to have high discretion in their investment decisions, because their firms have high credit quality. Such managers are also likely to pursue private benefits; an observation related to the free cash flow hypothesis. This study contributes to the empirical literature on credit ratings and firms' investment decisions. Research on the relationship between credit ratings and M&A activities is particularly scarce. We present new evidence that firms gain an information benefit through credit ratings. We also show that the principal– agent problem is particularly pronounced when firms have very high ratings.
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