Lead bank quality and adverse rating announcements

Abstract

PurposeThis paper seeks to examine whether the market values the monitoring activity undertaken by a quality bank in the presence of a credit rating agency. Specifically, the question is asked whether the quality of a lead lending bank influences a market reaction to adverse rating announcements concerning its borrowers.Design/methodology/approachThe event study methodology and various bank quality proxies (size, growth rate in assets, profitability, capital ratio, bank's credit rating, and ownership) are used to examine the market reaction when a borrower's bank loan rating is placed with negative implication or is downgraded.FindingsFirms which are certified and monitored by high‐quality banks are less susceptible to negative market reactions when adverse rating announcements are made.Originality/valueThe findings indicate high‐quality lending banks sustain investors' confidence in their borrowers in the face of deteriorating news. The paper argues that investors and borrowers value monitoring from a high‐quality bank, which is an implication of a bank having access to private information about its borrowers.