Are credit ratings forward-looking? – Evidence from India

Abstract

PurposeThis paper aims to examine the informational value of credit rating changes for investors. The article analyses whether credit rating changes indicate the future financial performance of a firm.Design/methodology/approachThe study employs pooled time-series cross-section regression technique and two-sample t-test for analysis. The paper utilizes a firm's operating profit as a proxy of its future financial performance to understand what inference can be drawn about future financial performance from a change in a firm's credit rating.FindingsThe paper finds that a firm operating profit declines in the year after a credit rating downgrade. However, no such significant relationship is evident in the case of a rating upgrade. The results are consistent across rating categories and individual years of the sample period.Research limitations/implicationsThe study uses non-financial corporate rating data; hence, the findings may not apply to credit rating changes in financial corporates and structured finance.Practical implicationsInvestors and analysts can incorporate credit rating downgrade by CRAs as a key input in a firm's future financial forecast. Analysts and investment managers can also look at credit rating changes of firms in the same industry and draw a definite conclusion about which firm is likely to see a higher deterioration in performance.Originality/valueThe author has not come across any literature that directly investigates credit rating changes from the perspective of information content about future financial performance.