Effect of Credit Rating Change Announcement On Shares in Indian Stock Markets

Ved Prakash Gupta and Anu Khandwal Department of Mathematics and Scientific Computing IIT Kanpur, Kanpur, Uttar Pradesh-208016, India

Abstract
Many researchers around the world have explored about the informational value of Credit Rating Announcements. Earlier studies include research on US, UK, Swedish, New Zealand, Australian and Turkey Markets. Through this paper we intend to show effect of credit rating announcement on companies listed with National Stock Exchange of India (NSE). Large market such as US and UK show little change to negative news and negligible change to positive news while a small market such as New Zealand market show significant reaction to both type of news. In India, results lie somewhere in middle with small and positive reaction to new assignment, small but negative reaction to upgrades, significant and negative reaction to downgrades and negative outlook, while positive reaction was observed for positive placements and finally affirmations had negative impact. These evidences suggest that Credit Rating agencies act as substitute information providers for firms. A separate analysis has also been done for getting results based on market capitalisation and industrial sector.

Introduction
The informational value of Credit Rating Agency is a controversial issue. This paper aims to analyse the reaction of Indian stock market to credit rating announcement. Many researchers have tried to answer this question by different methods but results are not the same. Many have argued the difference in credit rating reaction to small and large market. Some suggested that it may be due to liquidity factor (James and Edmister 1983) or informational content (Barry and Brown in 1984). Some difference may also be seen because of neglecting small market (Arbel and Strebel 1983). Credit rating agency may affect small market more than large market as they are neglected in comparison to larger one. Let us come back to our question whether credit rating announcement affect stock market or not. Many researchers found no effect of credit rating on stock prices (Weinstein 1977; Pinches and Singleton 1978).Many of them have also suggested that credit rating agency is not valuable for investors and only provided information relevant to the public (Kalpan and Urwitz 1979) and (Wakeman 1981) .Others argued that stock market reacted significantly to the information provided by credit rating announcement. All these findings are generally for large market US, UK and Australia.

The objective of this paper is to show the impact of credit rating announcements on share market for firms in relatively small (See Table 1) but growing market of India. Elayan et al (2003) studied small market reaction i.e. New Zealand market. He found that there was significant reaction for rating upgrades and no significant reaction for affirmations (class for which there is no rating change). The reason in that case was neglecting small markets which were overcome by the information that CRAs provided and invited attention of investors. Some features are very special with Indian Stock markets. NSE is bigger than New Zealand market and almost same as of Australian market but much more liquid.Indian markets are not as transparent as its counterparts and thus CRAs can play an important role. Diamond and Verrechia (1991) shown that in such markets reduction in information asymmetry can attract investment. On the whole, Indian economy has gone down during last 4 years which is clearly represented in the number of downgrades. Same number of companies was affirmed and only a few companies were upgraded (See table 2). Different sectors of the economy have responded very differently to credit rating actions and similar distinctions were seen in the reaction of companies based on their market capitalisation. Companies which underwent a downgrade twice or more in last 5 years have more negative reaction compared to total downgrades. The immediate effect of rating action was negligible but significant effect is observed in 4 to 6 month time. Almost all the companies had negative movement in this three year time period which indicates towards worsening Indian economy. In our paper we found no abnormal return during t-1 to t+1, where t is announcement date. We have also found that after 2 to 6 months the excess returns of stocks are significantly different from zero. This implies that credit rating agency may not be valuable just after the announcement but the information gets incorporated in stock prices after some time. Only a few companies which had rating announcement in 2009-2013 time period were listed with American Depository Receipt (ADR), hence a separate analysis was avoided for that because of lack of data. The rest of the paper includes the following topics: Topic 2- Review of the literature Topic 3- Empirical Findings regarding Credit Rating Topic 4-Hypothesis Topic 5- Data Description and Method of Analysis Topic 6- Empirical Results

Review of Literature
Theoretical Aspects of Credit Rating Announcements Ratings provided by CRAs are a measure of the long-term fundamental credit strength of companies, i.e. their long-term ability and willingness to meet their debt servicing obligations. More specifically, ratings apply either to the general creditworthiness of an obligor or to its obligations with respect to a particular debt security (senior and subordinated bonds, either secured or unsecured, collateralised debt structures, etc.) or other specific financial obligations. (Financial Stability Review, No. 4, June 2004) Stover (1999) notes that credit ratings implicitly provide certification associated in the debt market. He cites research by Wakeman (1981), Hsueh and Kidwell (1988), and Thompson and Vaz (1990) discussing the rating agencies function of providing estimates of firm credit quality. Wakeman(1991) argues that if CRAs use only public information to decide credit worthiness of a firm than that rating provide no extra information to investors. Kuhner (2001) views credit rating agencies as information intermediaries that help to overcome information asymmetries. He concluded that during periods of systematic risk, credit rating agencies do have some ability to distinguish between categories of fundamental credit risk. He argues that rating assignment do not provide any information that influences decision made by investors during normal time period. In the study of Swedish share market which has a size similar to New Zealand market but twenty six time share, it was found that due to higher liquidity there is more symmetry in information and has CRAs have little role to play. The effect of rating actions is visible in long term period. (The Effects of Credit Rating Announcements on Shares in the Swedish Stock Market,Hui Li et.al.)

Data Description and Method of Analysis

Data Description The events that were included for analysis were rating assignment, outlooks and ratings actions. The associated time period was from January 2010 to May 2013. A list of all credit rating action was obtained from CRISIL (Credit Rating Information Services of India Limited). Companies historical share prices were obtained from Bloomberg Database. Out of initial data, a final sample was considered on the following basis: 1. Companies to be considered should be listed with National Stock Exchange of India (NSE). 2. Daily and weekly return data must be available for all those companies for a period of 365 days before the rating announcement and 365 days after the announcement. 3. No other announcement was made during the t-1 to t+1 time period for any company which could have affected companys stock performance. Following these restrictions we have a final sample of 212 rating announcements during the study period. In table 2 we have summary of rating actions by year. The classification depicted in table categorized 6 rating announcements. Assignment is an event when credit rating is for the first time assigned. Upgrade is an event when firm's credit rating is upgraded. Downgrade is an event when firm's credit rating is downgraded. The

Outlook provides information to investors on the potential evolution of a rating, hence it increases the precision of the rating. Therefore, Positive outlook is an event when there is prediction that firm's rating may b raised. Negative outlook is an event when firm's credit rating have negative outlook. At last, Affirmation is an event for which there is no change in rating. There are 56(26.42%) assignments forming the largest section. There are 49(23.11%) and 21(9.91%) of downgrade and upgrade respectively. Of all rating actions, there are 25(11.79%) and 11(5.19%) of positive outlook and negative outlook respectively. Second largest section contains 50(23.58%) of affirmed ratings. Indian market is not a very transparent one (I am looking for some document to support this claim) and thus the role of credit rating agencies become important. CRAs come handy in decreasing the information gap between firms and investors and hence are needed as suggested by Wakeman (1981). Development of hypothesis So any new assignment will attract attention and capital from investors which bring us to our first hypothesis: Hypothesis 1: A new assignment of long term credit rating will show positive and significant impact on firms stock return. Earlier studies about US market shown that market does not respond to positive placements and only negative placements are associated with negative and significant reaction. However in a small market like India, which is 16 times smaller than US market, there is a possibility that both positive and negative placements will have significant reaction which brings us to our second hypothesis: Hypothesis 2: A credit watch placement associated with positive (negative) implication will have significant positive (negative) share market reaction. Large markets such as US and UK do not show significant reaction to upgrade and positive placement, but for India the possibility is high that both upgrades (downgrades) will have significant positive (negative) reaction on Indian share market. Taking this as the reasoning of our hypothesis, we state the third hypothesis: Hypothesis 3: It is expected that downgrade (upgrade) will be associated with significant negative (positive) excess returns. Hypothesis 4: Affirmations are not expected to generate any significant movement in share returns as in other markets both small and large. Methodology Classification of Rating Announcement If any company was not assigned any ranking in 6 years then the new action was considered an assignment. For example, company A was given a rating X in year 2002 and then a rating Y in year 2010 or 2009, then since the time period between two ratings was more than 6

years so the new rating was treated as a new assignment. The idea behind this decision was that in such a time gap, old rating would have lost its effect and the impact of the new rating will be similar of a new assignment. One particular discussion was common in all the research papers about this topic. Upgrades which were preceded by positive placements, upgrades preceded by negative placement, and normal upgrades were treated as separate categories. Since in case of India there were only 21 upgrades in total and dividing them into categories would have decreased the number of events in each category to very low digits, so upgrades were treated as a single category and in the later part of the project results were calculated and compared with other cases.

Calculation of Abnormal Return (AR) and Cumulative AR The market beta was calculated using the Nifty CNX 50 return data and share return of the concerned firm using the formula: =slope (Nifty Return Array, Share return Array) The data used for calculating this beta of one year prior to the rating event. The formula for calculating Abnormal return was : Actual Return Expected Return, where, Expected Return = Beta*Nifty Return Abnormal Returns are calculated for various time period, One year return, two month return, 4 month return, 6 month return, t 1 month to t+1 month, t 1 day to t+1 day Abnormal return. The reason behind calculating AR for such periods is that we wanted to see the time period at which CRAs show their impact the most. The next thing that we needed is the value of Cumulative Abnormal Returns (CAR) for every company and every event. For that we added the value of abnormal return. For example, to calculate the 2-month CAR for ADANI for the rating action on 7-Jun-2010, we added the value of abnormal return from the day 7-Jun-2010 to 7-August-2010, that sum was the value of CAR for 2 months. In case the data for 7-Aug-2010 was not available then the nearest to 7-Aug-2010 was used. This calculation of AR and CAR was done on daily and weekly basis. These calculation can be found in the excel file (Final Data and Charts, Sheet CAR Daily Basis and Weekly Data for CAR). For the events that occurred in or after May-2012, the data for One year after the event was not available, so in such cases CAR has been calculated for time periods which were plausible, so the CAR for one year will be marked as NA (Not Available) and rest values will be noted. There are some cases where consecutive events took place for a company with in a time period of one year or less. So suppose a company X undergone event A in June-2010 and event B in Dec-2010, so for event A calculating One year CAR, 6 Month CAR is meaningless. In such cases, One month CAR and 6 month CAR was marked NM (Not Meaningful).

Classification under various categories and Analysis

After having this data for all companies and events, next thing was to organise this data in tables and produce charts from them. Check out the sheet CAR in the same file where 6 different rating actions have been summarised and sheet Charts where a chart has been obtained for the same information. For further analysis, companies were divided into three categories based on their market capitalisation. The criteria of such division was obtained from NSE website which says, companies with M-Cap more than 5000 Crore INR are Large Cap companies, companies with M-Cap value between 5000 Crore and 1000 Crore are Mid Cap companies and companies with M-Cap less than 1000 crore are small cap companies. Detailed information about the CAR for various events on Capital basis can be seen in sheet Market Size in same file. Chart has also been plotted in the same file. Similar categorisation was done on the basis of industry, the details of which are in sheet sector wise and tables of sector. Some of the companies did not belong to any of the industry so they were left out of the classification. Namely 11 sectors were identified which were as follows: Auto Sector, Banking, Energy, Finance (Non- Banking), FMCG, IT, Media, Metal, Pharmacy, Realty and textiles. In the sheet Continuous Downgrade, those companies have been listed which undergone downgrade twice or more times in a period of five year. For example, take ARSS Infrastructure, it undergone downgrade in 2008, 2009 and again in 2011. The expected negative returns in such cases are different than normal downgrade cases. The result of such cases compared to normal downgrades are plotted in the Charts sheet in the same file. (Chart 14) Another analysis involved those downgrades which were preceded by negative placement and upgrades which were preceded by positive placement. Check chart 9 and chart 10 for results.

Additional Data for Mathematical Analysis based on different market proxy The data for Total sales, Total Assets, Market Cap and Market Beta was downloaded for all companies and was put in required format in the file named stock_price-requirement.xlsx.

Share Market NYSE NASDAQ LSE NSE NIFTY ASX NZSE

Number of Companies Listed 2308 2784 2864 1652 2122 233

Market Capitalization ($ US million) 16613000 4450000 3200000 1000000 1280000 49024

Average Amount Traded per day($ US millions) 153000 NA 6560 16097 4685 NA

Table 1: SUMMARY MARKET SIZE INFORMATION (Year end 2012)

Year 2010 2011 2012 2013 Total Weight

Up Down Positive Negative Assignment grade grade Outlook Outlook Affirmation Total 21 11 3 10 0 15 60 18 8 14 13 1 15 69 13 1 25 2 9 15 65 4 1 7 0 1 5 18 56 21 49 25 11 50 212 26.42% 9.91% 23.11% 11.79% 5.19% 23.58% 100.00% Table 2 : DISTRIBUTION OF CREDIT RATING ANNOUNCEMENT BY YEAR
Assignment Upgrade -20.51% -8.26% -2.21% -6.64% 3.75% -2.93% Downgrade -2.79% -9.96% -4.01% 16.17% -19.62% -1.78% Positive Outlook 3.05% 0.38% 3.15% 9.23% 6.38% -1.48% Negative Outlook 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Weight 28.30% 32.55% 30.66% 8.49% 100.00%

Affirmation 6.16% -5.63% 0.70% 7.14% -1.20% -1.04%

One year 2month 4month 6month t-30 to t+30 t-1 tot+1

8.14% 24.12% 38.22% 31.73% 1.95% 1.88%

Table 1 : Auto Sector Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 -1.64% 4.77% 1.67% -9.02% 6.18% -1.42% Upgrade -18.03% 3.73% 1.91% -1.81% -5.39% 5.13% Downgrade NA NA NA NA NA NA Positive Outlook -14.52% 9.13% -0.53% -3.26% 10.11% 3.71% Negative Outlook 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Affirmation 10.91% -7.92% 0.47% 7.53% 9.69% -0.43%

Table 2 :Bank Sector Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 -10.85% 4.75% 3.08% -3.93% 0.83% -2.25% Upgrade NA -21.03% -10.00% 11.87% -13.77% -4.98% Downgrade -28.40% -5.24% -10.02% -14.91% -0.19% -0.82% Positive Outlook 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Negative Outlook NA -21.57% -21.28% 1.93% -1.25% 3.55% Affirmation -32.26% -9.53% -13.02% -13.47% 4.82% 2.30%

Table 3 : Energy Sector Assignment One year 2month 4month 13.44% -1.10% -0.75% Upgrade Downgrade Positive Outlook Negative Outlook Affirmation -18.17% -0.10% -2.63%

6month t-30 to t+30 t-1 tot+1

5.86% -5.88% -0.92%

-6.15% 6.58% -2.72%

Table 4 : Finance Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 3.60% -3.72% 3.25% 4.70% -8.50% 0.65% Upgrade -15.09% 0.80% 3.35% 2.44% 6.65% 0.64% Downgrade -3.09% 5.80% -9.05% -17.56% 3.32% -1.83% Positive Outlook 11.99% 4.08% 11.05% 18.84% 0.45% 1.74% Negative Outlook NM -8.52% -20.95% -29.16% -10.38% -0.42% Affirmation -6.28% -1.34% -4.86% -11.51% -1.16% -0.17%

Table 5 : FMCG Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 -14.79% -1.24% -12.82% -10.47% 0.29% -2.40% Upgrade 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Downgrade NA -24.29% -36.36% 7.46% -3.63% 2.48% Positive Outlook 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Negative Outlook -46.50% -16.65% -26.03% -30.30% -8.41% -6.90% Affirmation 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Table 6 : IT Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 1.17% -0.61% -7.66% 0.67% -8.94% 0.00% Upgrade Downgrade -57.12% -9.60% 6.49% -40.06% -16.01% -3.59% Table 7 : Media Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 -32.24% 6.09% -11.79% -1.97% -7.84% -1.80% Upgrade 30.10% 9.85% 68.03% 48.14% -4.48% 2.69% Downgrade 12.93% -35.23% -35.45% -25.99% -30.41% 1.10% Positive Outlook -27.82% -12.85% -8.39% -15.21% 1.59% -5.64% Negative Outlook -156.20% -7.54% -5.96% -12.31% -3.87% -1.36% Affirmation -3.31% 24.82% 25.38% 24.47% 8.86% 1.53% Positive Outlook -20.24% 0.99% -3.80% -10.95% -13.95% -4.47% -14.66% Negative Outlook Affirmation -79.96% -67.86% -54.94% -83.90%

Table 8 : Metal Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 41.00% 10.71% 15.37% 16.20% -11.20% 0.85% Upgrade -0.96% 1.45% -0.94% 5.74% -8.21% 0.57% Downgrade -29.17% 4.49% -4.06% -14.68% 12.32% 2.50% Positive Outlook 4.62% -14.73% -20.64% -12.00% 4.30% -3.56% Negative Outlook Affirmation 22.98% -5.80% -23.77% -12.06% 4.27% -1.63%

Table 9 : Pharma Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 12.34% -21.64% 0.01% 7.99% -12.18% 1.49% Upgrade -45.30% 2.14% -6.51% -24.24% -2.12% 3.06% Downgrade -61.70% -3.47% -18.55% -37.88% -5.74% -4.77% Positive Outlook -76.46% -11.96% -7.20% -1.74% -4.38% 7.14% Negative Outlook NA -5.21% 10.12% -10.55% 6.35% -2.51% Affirmation -11.75% -3.33% -14.90% -13.91% -2.27% 1.10%

Table 10 : Realty Assignment One year 2month 4month 6month t-30 to t+30 t-1 tot+1 -3.52% -8.12% -11.62% -9.07% -9.96% -3.80% Upgrade -23.74% -6.83% -15.86% -3.93% -18.49% -1.70% Downgrade -71.47% -15.31% -48.20% -40.13% -16.32% -2.03% Positive Outlook 54.14% 2.67% 14.36% 7.29% 7.00% 0.29% Negative Outlook Affirmation -8.90% -5.42% -7.00% -9.45% -5.34% -0.10%

Table 11 : Textiles

Rating Crisil AAA Crisil AA Crisil A Crisil BBB Crisil BB Crisil B Crisil C Crisil D

Description Firms with this rating are considered to have highest safety and possess lowest credit risk Firms with this rating are considered to have high safety and possess very low credit risk Firms with this rating are considered to have adequate safety and possess low credit risk Firms with this rating are considered to have moderate safety and possess moderate credit risk Firms with this rating are considered to have moderate risk of default Firms with this rating are considered to have high risk of default Firms with this rating are considered to have very high risk of default Firms with this rating are in default or expected to be in default very soon CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from 'CRISIL AA' to 'CRISIL C' to reflect comparative standing within the category. CRISIL may assign rating outlooks for ratings from 'CRISIL AAA' to 'CRISIL B'. Ratings on Rating Watch will not carry outlooks. A rating outlook indicates the direction in which a rating may move over a medium-term horizon of one to two years. A rating outlook can be 'Positive', 'Stable', or 'Negative'. A 'Positive' or 'Negative' rating outlook is not necessarily a precursor of a rating change
Table 12 : Rating Scale for Long Term Firms

Note

Time Period /Rating Action One year 2month 4month 6month t-30 to t+30 t-1 tot+1

Assignment 1.91% 0.95% 2.04% 3.10% -0.79% -0.25%

UpGrade -13.03% -6.22% -4.82% -8.87% -10.81% 0.14%

Down Grade -19.65% -7.24% -9.33% -15.55% -3.81% -0.90%

Positive Outlook 7.68% -1.76% 2.12% 4.99% 4.02% -0.44%

Negative Outlook NA -12.94% -8.91% -8.50% -6.31% -1.57%

Affirmation -13.63% -0.95% -5.53% -7.17% -7.35% -1.20%

Table 13 : Small Capital Industries

Time Period /Rating Action One year 2month 4month 6month t-30 to t+30 t-1 tot+1

Assignment -3.10% 3.44% 0.85% -2.38% -3.52% -0.82%

UpGrade -4.28% 13.54% 10.74% 9.25% 13.23% 3.90%

Down Grade NA 2.80% -19.39% -20.36% -8.22% -4.51%

Positive Outlook 0.18% 5.40% 6.61% 3.68% 2.84% -0.09%

Negative Outlook NM NM NM NM NM NM

Affirmation 28.78% 4.09% 2.73% 14.96% 6.38% 1.35%

Table 14 : Mid Capital Industries Time Period /Rating Action One year 2month 4month 6month t-30 to t+30 t-1 tot+1 Assignment UpGrade -12.93% -14.73% -0.76% 14.07% -1.19% -3.35% Down Grade -67.38% -14.40% -21.56% -45.01% -6.03% 0.66% Positive Outlook -13.14% -3.53% -16.88% -7.33% -4.24% -0.58% Negative Outlook Affirmation

3.66% 3.79% 3.81% 6.89% 0.74% -0.55%

0.22% 0.51% -1.73% -0.60% 2.28% -1.30%

Table 15 : Large Capital Industries