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The Impact Changes in Credit Ratings on Stock Returns

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 The Impact of Changes in Credit Ratings
on Stock Returns

B G Poomima*, Naik Priyanka Umesh** and Y V Reddy***

This study broadly investigates the impact o f changes in credit ratings o f companies on the share
prices o f the mid-cap and small cap Indian companies, using event study methodology for a
window period o f 40 days. Specifically, the study investigates whether the investors respond
strongly to the changes in the ratings o f the companies and tests whether there is any significant
difference in the value o f the share prices before and after the announcement dates o f credit
ratings. The study considers a sample o f 12 mid-cap and 12 small cap companies listed in the
Bombay Stock Exchange for the period 2010-2014 to investigate the aforesaid issue. The study
concludes that there is a significant impact o f rating upgrades and downgrades on the stock returns
o f the investors. The impacts o f such announcements are more pronounced near the
announcement date and fa r o ff dates as well. Thus, the study observes that the rating
announcements have an immediate and long-term significant impact on firms’ share prices. The
impacts o f downgrade announcements on companies’ share prices are observed to be more
prominent than the upgrade announcements.

Introduction
With the impressive growth in the Indian industrial sector, the need for finance has increased.
In order to raise the capital, the companies are required to float various financial instruments
in the capital market. With the integration of different economies, the Indian companies can
now raise capital from anywhere around the globe. The investors today invest not only in
instruments issued by the domestic companies, but also in instruments issued by the foreign
companies. Introduction of new financial instruments like financial derivatives and asset-
backed securities has increased complexity to the investors, thereby creating confusion in
their understanding and analysis of complex terminologies for the purpose of making
investment decisions. Hence, reliable information from a trusted and well-regulated source
about the creditworthiness of the issuer is the need of the hour. Credit rating agencies have
come into existence for assisting such investors in taking accurate investment decisions by
assessing the credit standing of the borrowers. Credit rating agencies provide relevant

* A ssista n t Professor, D ep artm en t o f C o m m erce, Goa U niversity, G oa 403206, India.

E-mail: poomima79mysore@gmail.com
** A ssistan t Professor, D ep artm en t o f C o m m erce, Goa U niversity, Goa 403206, India.
E-mail: priyankanaikgd@gmail.com
*** Professor and D ean , Facu lty of C o m m erce, G oa U niversity, G oa 403206, India.
E-mail: yvreddy@unigoa.ac.in

© 2015 IUR All Rights Reserved.

information about the financial strength of the company. Credit rating agencies while
analyzing the creditworthiness of their clients, consider enormous factors relating to business
and financial aspects. Credit rating process is thus a comprehensive activity of analyzing
important parameters affecting the company’s present as well as future financial standing
either favorably or unfavorably. Under semi-strong form of market efficiency, the market is
well-versed with the publicly available information and the same are incorporated in the
stock prices. Thus, the present study attempts to find out whether the stock prices incorporate
the readily available information on credit ratings of the companies and how the market/
investors respond to the changes in credit rating. The paper aims to know whether there is an
impact of rating upgrades and downgrades on stock returns. It also tries to analyze the behavior
of the investors in case of credit rating upgrades and downgrades.

Literature Review
Many studies have used event study methodology to investigate the impact o f credit rating
upgrades and downgrades on stock returns. Afik et al. (2014) studied the significance of credit
rating changes for the investors in bond and equity markets. The study found that both the
markets respond only to downgrades and not to the positive rating announcements.

Emawtee and Robert (2014) conducted a research in Australian and Japanese capital
markets to identify the relationship between the credit risk and stock returns. The study
concluded that stock return and upgrades are directly related.

Jones and Marquis (2013) conducted a study using 43 US banks for a period of 12 years to
find out the relationship between stock returns and rating changes. The study concluded
that negative abnormal returns are highly associated with downgrades and positive abnormal
returns in post-announcem ent period are highly associated with both upgrades and
downgrades.

Sachdeva et al. (2013) analyzed 12 Indian banks for studying the movement of stock
returns with rating changes. It was found that the impact of upgrades on stock returns is
higher than that of downgrades. It was also found that the banks having higher market
capitalization show higher returns at the time of upgrade than the banks with lower market
capitalization.

Calderoni et a l (2009) analyzed the impact of rating actions on 12 European nation’s

stock markets for five years. By using ^-statistic, t-test and event study technique, it was
found that downgrades affect stock returns more than the upgrades.

Doron et al. (2009) used the monthly returns of all the firms listed on the US stock
exchanges to find out as to why a highly risky firm gives lower returns instead of high returns.
It was found that the stock of the firm with higher credit rating generates higher return than
the stock of a lower rated firm.

Winnie and Kam (2008) analyzed the impact of rating changes on stock returns of
companies in China. Th e results suggested that ratings given by the agencies have
informational value and the market is efficient to react to such announcements.

The Impact of Changes in Credit Ratings on Stock Returns 53

 Adam et al. (2007) analyzed the effects of rating changes on stock prices in Australian
markets. The study concluded that stock prices move up in case of an upgrade and fall in case
of a downgrade, and for small companies, the announcement effect is large.

Linciano (2004) analyzed 299 rating changes and their impact on Italian stock market
prices. It was concluded that ratings are a good source of information for long-term investors
who are interested in growth in their investment than the small investors.

Li et al. (2004) conducted a study on market reaction of rating changes on the stock
market of Iran. Using cross-multivariate regression test and event study, it concluded that
only downgrades provide valuable information to the stock market.

Data and Methodology

To find out the effect of credit rating upgrades and downgrades on stock returns and to test
whether company’s share prices change beyond expectations before and after rating
announcement, the event study methodology is used.

The steps followed in event study technique are as follows:

1. Defining the Event: Credit rating announcement day was taken as the event day
for carrying out the event study. Only rating upgrades and downgrades with respect
to long-term debt ratings were taken into account. The ratings announced by only
the top three Indian credit rating agencies, viz., ICRA Ltd., CRISIL Ltd. and CARE
Ltd., were used for the purpose of the study.

2. Selection of the Firms for Conducting the Study: The study covers the period
2010-2014. The credit rating announcement data was collected from Bloomberg
data source. A total of 24 companies were selected, out of which 12 companies
belonged to BSE mid-cap index, while the remaining 12 belonged to BSE small cap
index. The companies were selected based on the following two criteria:

a. Higher market capitalization in the respective index; and

b. The company must have at least one upgrade and one downgrade.

3. Defining the Estimation Window, Event Window and Post-Event Window:

a. Estimation window of 110 days prior to the event window was chosen in order
to compute the two parameters, i.e., beta (an indicator market risk) and the
intercept.
b. Event window is of 20 days prior to the event day.
c. Post-event window is of 20 days after the event day.

Since very negligible impact was found beyond 20 days prior to and after the announcement
dates, the estimation window was limited to only 40 days (Figure 1).

4. Computation o f Expected Returns: In order to compute normal or expected returns,

the market model method was used. The following formula was used to compute
the expected returns:

54 The 1UP journal of Financial Risk Management, Vol. XII, No. 3, 2015
 Figure 1: Estimation Window and Event Window

110 days 20 days 20 days

« -------------------------------------------------------------------------- ► M----------— ► < ----------

t—--110 t= -2 0 t= 0 £= + 20
Estimation Window Event Window

E(R u) = a i + f i x R mc

where E(R.£) = Expected return of stock; a. = Intercept of the stock; /?. = Beta value
of the stock;’ and R mt = Market return.

This method is based on the assumption that there is a linear relationship between
expected and market returns during the event window. It also provides more sensitive
adjustment of return on a stock for two reasons:

a. The intercept of regression indicates return on stock on an average given that

market return is zero.

b. /?, x Rmt captures sensitivity of stock returns to market returns.

5. Computation of Abnormal Returns: To know whether the event leads to returns

which are beyond the expectations, abnormal returns were computed by subtracting
expected returns from actual returns.

AR = Rl[- E ( R l[)

where R = Actual return on the stock, and E(R,t) = Expected return on stock.

6. Computation of Aggregate Abnormal Returns: To make overall inferences, daily

abnormal returns were summed up and hence cumulative abnormal returns were
computed.

7. Analyzing the Significant Impact: In order to analyze whether there is a significant

impact of the event on stock returns, t-tests of abnormal returns and cumulative
abnormal returns were calculated. Similarly, p~values for the t-tests were calculated
in order to test their significance. 1%, 5% and 10% significance levels were used to
test the significant impact. Final interpretations were given based on the comparison
between abnormal returns, expected returns and cumulative abnormal returns
whose values were plotted on the graph for every announcement.

Results and Discussion

Tables 1 and 2 depict the rating upgrades and downgrades of the the selected BSE mid-cap
and small cap companies respectively. Returns over a window period of 41 days of various
companies which witnessed the upgrade and downgrade ratings on the above-mentioned

The Impact of Changes in Credit Ratings on Stock Returns 55

 Table 1: Selected M id-C ap Com panies with T h eir R ating Upgrades and Downgrades

Upgrades - Long-Term Downgrades - Long-Term

Market
Company Name Capitalization Date of Current Last Date of Current Last
Agency Agency
Announcement Rating Rating Announcement Rating Rating
Arvind Ltd. 09/01/2010 CRIS B+ D 02/11/2013 CRIS D BBB+
8027.49 09/05/2011 CARE BBB+ BBB-

08/08/2014 CARE A+ A
Ceat Ltd. 3138.72 05/02/2011 CARE BBB BBB- 1/30/2013 CARE BBB- BBB+
Cholamandalam Investment 3/28/2012 CARE AA A+ 08/10/2012 CARE A+ AA-
and Finance Co Ltd.
The IUP Journal of Financial Risk Management, Vol. XII, No. 3, 2015

8510.17 10/28/2014 CARE AA AA- 07/09/2012 CARE AA- AA

12/22/2011 CARE A+ AA
GMR Infrastructure Ltd. 10/12/2010 ICRA A- BBB 12/12/2012 ICRA BBB BBB+

7719.41 11/20/2012 CARE BBB+ A-

12/14/2011 ICRA BBB+ A-

Jain Irrigation Systems Ltd. 3/22/2011 CRIS A- BBB+ 8/29/2012 CARE B+ BB+
3232.28 4/30/2014 CARE B BB - BB+ 8/28/2012 CRIS B+ A-
6/18/2012 CARE B B+ BBB+
Jet Airways India Ltd. 4787.56 11/27/2014 ICRA BB C 11/30/2011 ICRA B B+ BBB-

8/21/2014 ICRA D BB
PTC India Financial Services Ltd. 3501.78 6/13/2014 ICRA A+ A 8/28/2012 ICRA A A+
Sobha Ltd. 4577.62 12/28/2010 ICRA B BB - B B+ 1/23/2013 ICRA BB- BBB+

08/09/2012 ICRA BBB+ BBB

4/16/2010 ICRA BB BB-

 Table 1 (Cont.)

Upgrades - Long-Term Downgrades - Long-Term

Market
Company Name Capitalization Date of Current L ast Date of Current L ast
Agency Agency
Announcement Rating Rating Announcem ent Rating Rating

Sterlite Technologies Ltd. 2598.25 09/01/2010 CRJS AA- A+ 12/27/2011 CRIS A+ AA-

01/06/2010 CRIS A+ A-

Trent Ltd. 4871.74 11/04/2010 CARE AA AA- 10/11/2013 CARE AA- AA

01/04/2010 ICRA A+ AA-

Tube Investments of India Ltd. 6978.14 11/02/2010 CRIS AA AA— 09/01/2010 CRIS AA~ AA

TVS Motor Co Ltd. 13865.42 9/19/2014 CARE AA AA- 1/18/2010 CARE A+ AAA

4/26/2011 CARE AA- A+

Source: Bloomberg, www.moneycontrol.com

Table 2 : Selected Small C ap C om panies with T h eir R ating Upgrades and Downgrades

Upgrades — Long-Term Downgrades - Long-Term

Market
Company Name Capitalization Date of Current Last Date of Current Last
Agency Agency
Announcement Rating Rating Announcement Rating Rating

Aegis Logistics Ltd. 1826.31 05/10/2011 CARE AA AA- 11/21/2012 CARE AA- AA

Alok Industries Ltd. 1364.92 7/23/2010 CARE A+ A 07/06/2012 CARE A A+

10/01/2014 CARE BBB- BBB

Dynamatic Technologies Ltd. 1777.82 11/25/2014 ICRA BBB BBB- 06/04/2010 ICRA BBB+ A-

08/11/2014 ICRA BBB- BB+ 8/16/2012 ICRA B B+ BBB

6/15/2011 ICRA BBB BBB+

Indo Count Industries Ltd. 1633.28 8/18/2014 CARE BBB- B 5/14/2012 CARE D C

07/08/2010 CARE C D
 announcement dates are

Rating

BBB+

BBB+
Last

AA+

AA-
cA

BB+
examined in detail

BBB
+
< < 59
CQ i <
CQ
CQ
(see Figures 2 to 5). Only
those companies which

Current

BBB+
Rating
<+
Downgrades - Long-Term

BBB-
+

BB+
BBB
+ witnessed highest impact

AA
03 CQ £3
< <: Q CQ ca < CQ
that continued for a
maximum period of seven
Agency

CARE

j CARE

CARE

CARE

CARE

CARE
ICRA

ICRA

ICRA
CRIS

CRIS
days on account of credit

CRIS

CRIS
rating announcements

l
are shown in Figures 2
Announcement

10/23/2012 and 3.
08/07/2012

02/01/2009

01/06/2010

09/04/2014
06/03/2013
11/04/2011

04/02/2013

8/14/2012

7/28/2014

4/26/2013
Date of

2/25/2011

8/26/2011
It is observed from
the figures th at
cum ulative abnorm al
returns have decreased
Rating

BBB+
Last

1 BBB-
B B+
cA over a period o f time

Source: Bloomberg, www.moneycontrol.ccm

< <
!
<: $ <
CQ
pa i significantly post the
announcement dates for
Current
Rating

BBB+

BBB-
AA+
Upgrades - Long-Term

BBB+
+ +
Table 2 (Cont.)

all the small cap

< < < <
companies, irrespective
of whether there is a
Agency

CARE

CARE

CARE

CARE

CARE

CARE

CARE
ICRA

ICRA
CRIS

upgrade or downgrade in
the ratings of the
company. The decrease
Announcement

11/19/2010

10/25/2010

08/06/2014
09/01/2010

07/08/2014

12/20/2010

07/03/2014
08/05/2011

is drastic post the event

7/18/2014
3/27/2012
Date of

date, implying that the

exp ectatio n s o f the
investors before the
............ ..............
1
1
i

announcements did not

Capitalization
Market

match with the event.

1498.58

1408.48

1893.79
2704.75

2847.46

1920.66

2353.40

2972.05
.

On the event date, there

is no sign ifican t
i_

difference between the

expected return and
Shasun Pharmaceuticals Ltd.

Simplex Infrastructures Ltd.

abnormal return for the

JK Tyre& Industries Ltd.
Name

Suven Life Sciences Ltd.

small cap companies.

Magma Fincorp Ltd.
Lancolnfratech Ltd.
JBF Industries Ltd.

It is evident from the

Company

Rolta India Ltd.

graphs o f m id-cap
companies (Figure 4)
where ratings were
upgraded, th a t the

58 The 1UP Journal of Financial Risk Management, Vol. XII, No. 3, 2015
 Figure 2: Smalt Cap Companies - Upgrades

Aegis Logistics Ltd.

0.10
0.05

0
-0 .0 5

- 0.10

-0 .1 5

- 0.20

_0 Q2 ^ fc nj r~P. ^
- 0 * 0 4 ......................................................................
- 0.06

- 0.08

I>ynamatic Technologies Ltd.

0.05
0
-0 .0 5
- 0.10

-0.15
- 0.20
- 0 .2 5
-0 .3 0
- 0 .3 5
- 0 .4 0

JK Tyre & Industries Ltd.

0
-0 .0 5

- 0.10

- 0 .1 5

- 0.20

-0 .2 5

The Impact of Changes in Credit Ratings on Stock Returns 59

 Figure 3: Small Cap Companies - Downgrades

Alok Industries Ltd.

0.10
0.05
0
-0 .0 5
- 0.10
-0 .1 5
- 0.20

-0 .2 5
-0 .3 0

/\ t ; V /*'*
0 -N /^ - J 4 - P - W ' QV -AA: ; t
- 0.01
-0.02—V^-
-0.03— -
- 0.04 -----------
- 0.05 -----------
- 0 .0 6 -----------

Dynamatic Technologies Ltd.

0.05
0
-0 .0 5
- 0.10
-0 .1 5
- 0.20
-0 .2 5

Simplex Infrastructures Ltd.

0
- 0.1
- 0.2
-0 .3
- 0 .4
-0 .5
- 0.6

-0 .7
- 0.8
Expected Return Abnormal Return ■Cumulative AR

60 The IUP Joumai of Financial Risk Management, Vol. XII, No. 3, 2015
 Figure 4 : Mid-Cap Companies - Upgrades

Arvind Ltd.

Cholamandalam Investment and Finance Co Ltd.

0
- 0 .0 5
- 0.10
-0 .1 5
- 0.20
-0 .2 5
-0 .3 0
-0 .3 5

GMR Infrastructure Ltd.

0
-0.02
-0 .0 4
-0 .0 6
-0 .0 8
- 0.10
- 0.12
- 0 .1 4
- 0 .1 6
- 0 .1 8

Jet Airways India Ltd.

0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
- 0.1

Expected Return Abnormal Return ■Cumulative A R

The Impact of Changes in Credit Ratings on Stock Returns 61

 Figure 5: Mid-Cap Companies - Downgrades

Jain Irrigations Systems Ltd.

0.10
0.05
0
-0 .0 5
- 0.10
-0 .1 5
- 0.20

-0 .2 5
-0 .3 0
-0 .3 5

0.10
0.05
0
-0 .0 5
- 0.10

-0 .2 5
-0 .3 0

GMR Infrastructure Ltd.

cumulative abnormal returns of mid-cap companies unlike small cap companies have increased
post the event date of a few companies like Arvind Company Ltd. and Jet Airways India Ltd.
For the rest of the companies, only the immediate positive impact was evident and gradually
with the lapse of time there were negative returns. There is negligible difference between the
expected return and the abnormal return on the event dates. Abnormal returns increased
post the event dates for mid-cap companies on account of upgrading.

Tables 3 and 4 provide a brief summary of the number of significant positive and negative
returns in case of upgrade and downgrade announcements with respect to each of the companies
selected during the period before and after the announcement of rating change.

For selected BSE mid-cap companies depicted in Table 1, it is observed from Table 3 that
12 downgrades out o f a total of 21 downgrades have a negative significant impact on the stock
returns which are higher than the negative returns before the announcement of ratings.
Hence, downgrades have a very high and significant impact on stock returns. In case of
upgrades, the results show that in most of the cases there is a positive impact on stock

62 The 1UP Journal of Financial Risk Management, Vol. XII, No. 3, 2015
returns. But the number of positive returns after an upgrade is very less as compared to the
pre-announcement period. This means that the upgrade has a very low impact on the stock
returns.

Table 3 : Im pact on M id-Cap Com panies

Effect
Date of
S. After the Event
Company Rating Before the Event
No.
Announce­ Number
Number
ment Return Return
of Days of Days

For Rating Upgrades

1. TVS Motor Co Ltd. 9/19/2014 Positive 8 Positive 5

4/26/2011 Positive 16 Positive 5

2. Cholamandalam Investment 3/28/2012 Positive 13 Positive 20

and Finance Co Ltd.
10/28/2014 Negative 10 Negative 20

3. Arvind Ltd. 09/01/10 Positive 17 Positive 18

09/05/11 Negative 4 Nil 0

08/08/14 Nil 0 Positive 7

4. GMR Infrastructure Ltd. 10/12/10 Negative 11 Negative 20

5. Tube Investments of India Ltd. 11/02/10 Positive 10 Positive 2

6. Trent Ltd. 11/04/10 Nil 0 Negative 15

7. Jet Airways India Ltd. 11/27/2014 Nil 0 Positive 18

8. Sobha Ltd. 12/28/2010 Nil 0 Negative 8

08/09/12 Nil 0 Negative 12

4/16/2010 Positive 5 Positive 16

9. PTC India Financial Services Ltd. 6/13/2014 Positive 15 Positive 20

10. Jain Irrigation Systems Ltd. 3/22/2011 Nil 0 Positive 13

4/30/2014 Positive 15 Positive 4

11. Ceat Ltd. 05/02/11 Positive 16 Positive 19

12. Sterlite Technologies Ltd. 09/01/10 Positive 2 Positive 19

01/06/10 Negative 2 Negative 9

For Rating Downgrades

1. TVS Motor Co Ltd. 1/18/2010 Positive 10 Positive 16

2. Cholamandalam Investment 08/10/12 Positive 19 Positive 18

and Finance Co Ltd.
07/09/12 Nil 0 Positive 14

12/22/2011 Negative 2 Negative 2

3. Arvind Ltd. 02/11/13 Negative 13 Negative 20

4. GMR Infrastructure Ltd. 12/12/12 Negative 20 Negative 11

The Impact of Changes in Credit Ratings on Stock Returns 63

 Table 3 (Cont.)
Effect
Date of
S. After the Event
Company Rating Before the Event
No.
Announce­
Number Number
ment Return Return
of Days of Days

11/20/2012 Negative 6 Negative 20

12/14/2011 Negative 2 Positive 2

5. Tube Investments of India Ltd. 09/01/10 Negative 1 Negative 10

6. Trent Ltd. 10/11/13 Negative 5 Negative 17

01/04/10 Nil 0 Negative 14

7. Jet Airways India Ltd. 11/30/2011 Positive 9 Positive 11

8/21/2014 Nil 0 Negative 16

8. Sobha Ltd. 1/23/2013 Positive 6 Positive 17

9. PTC India Financial Services Ltd. 8/28/2012 Nil 0 Nil 0

10. Jain Irrigation Systems Ltd. 8/29/2012 Negative 7 Negative 19

8/28/2012 Nil 0 Negative 17

6/18/2012 Nil 0 Negative 5

11. Ceat Ltd. 1/30/2013 Nil 0 Negative 6
12. Sterlite Technologies Ltd. 12/27/2011 Nil 0 Positive 7

Table 4 : Im pact on Small C ap Companies

Effect
Date of
S.
Company Rating Before the Event After the Event
No.
Announce­
Number Number
ment Return Return
of Days of Days

For Rating Downgrades

1. Aegis Logistics Ltd. 5/10/2011 Nil 0 Negative 20

2. Alok Industries Ltd. 7/23/2010 Positive 8 Positive 16
3. Dynamatic Technologies Ltd. 11/25/2014 Negative 1 Negative 20

8/11/2014 Negative 1 Negative 20

4. Indo Count Industries Ltd. 8/18/2014 Negative 2 Negative 10
7/8/2010 Negative 11 Negative 2
5. JBF Industries Ltd. 11/19/2010 Nil 0 Negative 13
6. JK Tyre & Industries Ltd. 10/25/2010 Negative 2 Negative 20

08/06/2014 Nil 0 Negative 15

7. Lancolnfratech Ltd. 09/01/2010 Nil 0 Negative 13
8. Magma Fincorp Ltd. 08/05/2011 Negative 18 Negative 20

64 The IUP Journal of Financial Risk Management, Vol. XII, No. 3, 2015
 Table 4 (Com.)
Effect
Date of
S. Before the Event After the Event
Company Rating
No.
Announc­ Number Number
ement Return Return
of Days of Days

9. Rolta India Ltd 07/08/2014 Negative 4 Negative 19

10. Shasun Pharmaceuticals Ltd. 7/18/2014 Positive 3 Negative 4

3/27/2012 Nil 0 Positive 11

11. Simplex Infrastructures Ltd. 12/20/2010 Negative 8 Negative 16

12. Suven Life Sciences Ltd. 07/03/2014 Nil 0 Positive 12

For Rating Downgrades

1. Aegis Logistics Ltd. 11/21/2012 Negative 13 Negative 6

2. A lok Industries Ltd. 07/06/2012 Negative 7 Negative 20

10/01/2014 Nil 0 Negative 12

3. Dynamatic Technologies Ltd. 06/04/2010 Negative 8 Negative 20

08/16/2012 Nil 0 Positive 19

06/15/2011 Nil 0 Positive 17

4. Indo C ount Industries Ltd. 05/14/2011 Positive 3 Positive 15

5. JB F Industries Ltd. 11/04/2011 Negative 5 Negative 5

6. JK Tyre & Industries Ltd. 04/02/2013 Negative 2 Positive 4

08/14/2012 Nil 0 Positive 5

7. L anco Infratech Ltd. 10/23/2012 Positive 19 Positive 4

08/07/2012 Nil 0 Negative 19

8. Magma Fincorp Ltd. 07/28/2014 Negative 1 Negative 3

9. Rolta India Ltd. 06/03/2013 Nil 0 Negative 7

10. Shasun Pharmaceuticals Ltd. 02/01/2009 Negative 9 Positive 9

01/06/2010 Negative 13 Negative 20

02/25/2011 Negative 11 Negative 20

11. Sim plex Infrastructures Ltd. 09/04/2014 Negative 1 Negative 20

12. Suven Life Sciences Ltd. 04/26/2013 Positive 15 Positive 9

Negative 4 Negative 6

For BSE small cap companies depicted in Table 2, it is observed from Table 4 that around
13 downgrades out of a total of 20 downgrades have a negative significant impact on the stock
returns as compared to the significant returns before the downgrade announcement, thus
showing a higher impact on the stock returns. For upgrades, the results indicate that out of 16
upgrade announcements, only three upgrade announcements are leading to highly significant
positive returns to the investors. This shows that upgrade announcements have very low
impact on the stock returns.

The Impact of Changes in Credit Ratings on Stock Returns 65

 In some cases, upgrades are leading to negative returns, but it still has a positive impact on
the stock returns since the number of significant negative returns has decreased after the
announcement of an upgrade as compared to that of pre-announcement period. In some
cases, the downgrades are leading to positive returns in the post-announcement period and
the number of positive returns is more than that before the downgrade announcement. This
indicates that there may be some speculative activities being carried out by the market
participants for a speculative profit in future.

Impact of the Rating Changes on the Returns of Mid-Cap and Small Cap
Companies
In case of the downgrades, most of the small cap companies are giving significant positive
returns; this suggests that the stock is performing very well irrespective of the downgrade
announcements and is giving higher returns than the expected returns. But this is not true in
case of mid-cap companies. In mid-cap companies, downgrades are having an adverse negative
impact on the stock returns. The stock returns are positive over the post-announcement
period. This indicates that the shareholders are very much sensitive to the rating changes
and react in accordance to the rating changes, thereby the actual returns fetched are lower
due to decrease in the prices of the stock.

In case of upgrades, the mid-cap companies’ stocks are outperforming the market and are
able to fetch higher returns after the upgrade than before, whereas the small cap companies
are not able to give significant positive returns to the investors.

Thus, it can be concluded that the investors in case of mid-cap companies give more
relevance to both the upgrade and downgrade announcements. At the same time, the investors
of small cap companies are indifferent to upgrades and downgrades. It can be also said that the
new investors invest in the downgraded small cap companies with a hope that they will
become large cap companies in future.

Conclusion
Credit rating is a professional opinion about the credit standing of an issuer and is helpful for
all the market participants, especially for the investors to take rational investment decisions.
The study examined the impact of credit rating upgrades and downgrades and also studied
the behavior of the investors in case of such announcements by evaluating a total of 24
companies forming a part of BSE mid-cap and small cap index.

The top 12 companies in each BSE mid-cap and BSE small cap index were selected based
on market capitalization and the impact of rating upgrades and downgrades was analyzed
using event study technique and t-tests.

The study concludes that there is a significant impact of rating upgrades and downgrades
on the stock returns of the investors. The impact of such announcements can be seen more
on and around the date of announcement as well over a long period after the announcement.
Thus, it can be concluded that the rating announcements have an immediate and long-term
significant impact on firms’ value.

66 The IUP Journal of Financial Risk Management, Vol. XII, No. 3, 2015
 The results also indicate that a majority of the downgrade announcements are having
significant negative impact on returns, whereas the upgrade announcements are having
significant positive impact on the returns in very few cases.

Moreover, the impact of downgrade announcements is more than that of upgrade

announcements. Such impact can be seen only in case of daily cumulative abnormal returns
and not in terms of daily abnormal returns. This suggests that as the daily abnormal returns
are cumulated over a period, the impact of rating upgrade and downgrade increases.

The results also show that the stock prices reflect the necessary information available
publicly and also there are significant abnormal returns to the investors. Thus, it contradicts
the semi-strong form of market efficiency hypothesis. ♦♦♦

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The Impact of Changes in Credit Ratings on Stock Returns 67

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