Credit ratings and corporate risk-taking behavior: evidence from Korea

ABSTRACT

We study the period following the 1997 Asian financial crisis to show that the credit rating downgrades affect corporate risk-taking behaviour. We treat the crisis as an exogenous shock that led to improvements in the informativeness of Korea’s credit rating system, and we determine that firms that have experienced credit rating downgrades reduce their risk-taking following the crisis. However, we show that this impact is less pronounced for chaebol-affiliated firms. Furthermore, we present chaebol firms’ characteristics that mitigate the negative impact of credit rating downgrades on their risk-taking behaviour – high net internal capital flow and large ownership concentration. (JEL G24, G32)

KEYWORDS:

• Risk-Taking
• credit rating
• chaebol
• internal capital market

JEL CLASSIFICATION:

• G24
• G32

Acknowledgement

We wish to thank the editor (Mark Taylor) and three reviewers for their guidance and constructive comments. Any remaining errors are ours.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 Kisgen (2009) shows that firms react asymmetrically to credit rating changes, reducing leverage after downgrades but making no particular adjustment after the upgrades. Other literature show that credit rating downgrades have much severe impact on the firms’ financial decisions (Ederington and Goh 1998; Hand, Holthausen, and Leftwich 1992). Thus, our paper concentrates on the impact of credit rating downgrades. However, our supplementary analyses show that the firms do not make significant adjustment after the credit rating upgrades.

2 Firms with high levels of state ownership are heavily influenced by government policies (Cui and Jiang 2012). For example, state-owned firms may be conservative in risk-taking activities under government policies that may value social stability and rent-seeking (Fogel, Morck, and Yeung 2008; John, Litov, and Yeung 2008). In addition, financial firms are also excluded because of their unique firm characteristics different from non-financial firms.

3 For example, risk-taking activity of a firm at year t is the standard deviation of its return on total assets for the years t, t + 1, t + 2.