When Do Stock Analysts Find Bond Rating Changes

Accounting and Business Research
ISSN: 0001-4788 (Print) 2159-4260 (Online) Journal homepage: http://www.tandfonline.com/loi/rabr20
When do stock analysts find bond rating changes

informative?
Boochun Jung, Konduru Sivaramakrishnan & Naomi Soderstrom
To cite this article: Boochun Jung, Konduru Sivaramakrishnan & Naomi Soderstrom (2016)
When do stock analysts find bond rating changes informative?, Accounting and Business
Research, 46:1, 3-30, DOI: 10.1080/00014788.2015.1014464
To link to this article: http://dx.doi.org/10.1080/00014788.2015.1014464
Published online: 27 Aug 2015.
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Download by: [Purdue University Libraries] Date: 06 April 2016, At: 11:53
Accounting and Business Research, 2016
Vol. 46, No. 1, 3– 30, http://dx.doi.org/10.1080/00014788.2015.1014464
When do stock analysts find bond rating

changes informative?†
BOOCHUN JUNGa, KONDURU SIVARAMAKRISHNANb and

NAOMI SODERSTROMc∗
Downloaded by [Purdue University Libraries] at 11:53 06 April 2016
a
School of Accountancy, Shidler College of Business, University of Hawaii at Manoa, Honolulu,
HI, USA; bJones Graduate School of Business, Rice University, Houston, TX, USA;
c
Department of Accounting, University of Melbourne, Melbourne, Australia
Credit rating agencies (CRAs) have considerable privileged access to corporate management
and are therefore a potentially important source of information to the equity market. We
study how stock analysts incorporate bond ratings in their earnings forecasts. We develop an
economic framework to explain why equity analysts might look to CRAs as an information
source, especially after Regulation Fair Disclosure. Using this framework, we characterize
the association between ratings changes and earnings forecast revisions surrounding these
changes. We examine whether the extent to which equity analysts glean information from
ratings changes is related to the extent and importance of information conveyed in the
ratings change and analysts’ information uncertainty. We find that characteristics we
examine are strongly related to stock analysts’ use of information in rating downgrades.
Keywords: equity analysts; debt rating changes; analyst forecast revisions; Regulation Fair
Disclosure
1. Introduction
We examine the importance of credit rating changes as an information source for equity analysts
forecasting corporate earnings. Credit rating agencies (CRAs) have considerable access to corpor-
ate management and are therefore an important source of information for capital market partici-
pants. The extent to which equity analysts rely on this information source is likely to be a function
of the information environment, that is, whether CRAs have access to information that the ana-
lysts do not, and whether the information in ratings changes helps resolve uncertainty.
In prior research, Ederington and Goh (1998) use data from 1984 to 1990 to document sig-
nificant negative revisions in stock analysts’ earnings forecasts after credit rating downgrades.
This evidence, however, does not permit any inference about the nature and the direction of infor-
mation flow between equity analysts and bond analysts. This is because prior to 2000, there was
†
Data availability: All data used in this study are publicly available from the sources identified in the text.
∗
Corresponding author. Email: naomiss@unimelb.edu.au
# 2015 Taylor & Francis

4 B. Jung et al.
no reason to expect either CRA or equity analysts to be on average better informed. CRAs and
equity analysts both enjoyed access to corporate management. The association that Ederington
and Goh found between ratings changes and forecast revisions may simply reflect a response
to common information. Since 2000, however, Regulation Fair Disclosure (hereafter Reg. FD)
has significantly altered the information environment in which equity analysts and CRAs
operate.1 This structural change provides a unique opportunity to characterize the information
flow between equity analysts and CRAs.
In this paper, we develop an information framework to explain why equity analysts might look
to CRAs as an information source, especially after Reg. FD. Using this framework, we character-
ize the association between ratings changes and earnings forecast revisions surrounding these
changes. In particular, we investigate whether information content of ratings changes, information
uncertainty faced by analysts, and select firm characteristics affect the association between ratings
changes and earnings forecast revisions.
As noted earlier, Reg. FD has fundamentally changed the information environment. It denies
equity analysts the private access to corporate management they previously enjoyed. It is reason-
able to expect that analysts would seek alternate sources of information to compensate for this
loss. CRAs are one such source, since Reg. FD does not similarly deny CRAs access to corporate
management. Indeed, Jorion et al. (2005) find that after Reg. FD, stock price reaction to down-
grades (upgrades) is significantly more negative (positive), indicating that CRAs’ role as a
source of information to the market has increased in importance subsequent to Reg. FD. This
asymmetric impact of Reg. FD on the information channels available to equity analysts and
CRAs has important implications for the flow of information between them.
It is important to note that by relying on the ratings changes, equity analysts do not bring new
information to the marketplace. To the extent that their forecasts merely reflect information con-
tained in publicly announced ratings changes, the market would arguably rely less on analyst fore-
casts as a source of information,2 thus hampering the ability of analysts to compete effectively in
the market for information. Thus, whether and to what extent equity analysts depend on CRAs as
an information source is a matter for empirical examination.
The magnitude of a ratings change, whether a ratings change is a “crossover” (i.e. a ratings
change crossing between investment and speculative grade) or not, and whether a ratings
change is within a speculative or investment grade, are all proxies for how much information
the ratings change conveys. We test whether earnings forecast revisions in response to ratings
changes are associated with these characteristics, and as expected, we find that downgrades
with these characteristics lead to significantly more negative earnings forecast revisions.
However, we do not find similar evidence for upgrades.3 These results suggest that at least for
downgrades, the association between analyst forecast revisions and ratings changes is information
related. We cannot rule out the possibility that this is due to the common information to which
equity analysts and CRAs have access (especially pre-Reg. FD, since both equity analysts and
CRAs had unfettered access to corporate management).
However, our results are consistent with the hypothesis that the association between earnings
forecast revisions and ratings changes is stronger in the post-Reg. FD period compared to the pre-
Reg. FD period. In particular, we find that after Reg. FD, equity analysts appear to place more
weight on rating downgrades in revising their earnings forecasts. We do not find a similar
effect for upgrades. Additional tests indicate that our results with respect to Reg. FD are not
attributable to other important events and regulatory changes that took place around the same
time, such as the Enron collapse, the Sarbanes-Oxley Act, and the Global Research Analyst
Settlement. Thus, given the asymmetric effect of Reg. FD on the information environments of
equity analysts and CRAs, these results suggest that equity analysts look to CRAs as a source
of information in the post-Reg. FD era.
Accounting and Business Research 5
We next examine whether information uncertainty is related to the direction of information

flow between equity analysts and CRAs. Like other market participants, equity analysts are
likely at a greater disadvantage when there is more information uncertainty and thus, have a stron-
ger incentive to look for other sources of information. We hypothesize that rating changes are
more highly weighted in earnings forecast revisions for companies characterized by greater infor-
mation uncertainty. Using earnings forecast dispersion and analyst coverage to proxy for infor-
mation uncertainty, we provide evidence consistent with our hypothesis for downgrades, but
not for upgrades. Our results are robust to several sensitivity tests that address various measure-
ment issues and time period effects. In sum, our study contributes to the literature by extending
Ederington and Goh (1998) and analyzing determinants of the association between ratings
changes and earnings forecast revisions surrounding the changes, especially in light of changes
in the information environment caused by Reg. FD.
The paper proceeds as follows. Section 2 reviews the literature and develops our hypotheses.
Section 3 describes sample selection and summary statistics. Section 4 contains our main results
while Section 5 reports additional analyses and robustness tests. Section 6 concludes.
2. Literature review and hypothesis development

It is widely acknowledged that because CRAs’ information advantage mainly arises from their
private access to management, the nature and the magnitude of ratings changes convey new infor-
mation to equity and credit markets. Prior studies (e.g. Holthausen and Leftwich 1986, Hand et al.
1992, Jorion et al. 2005) find that the stock market reacts more strongly: (1) to multi-grade than
single-grade downgrades; (2) to downgrades within speculative grades than to those within
investment grades; and (3) to downgrades from investment to speculative grade than other
downgrades.4
Prior studies also document that the stock market reaction is stronger for downgrades than for
upgrades (Holthausen and Leftwich 1986, Hand et al. 1992, Ederington and Goh 1998). We
expect that stock analysts’ responses would also be asymmetric between downgrades and
upgrades, similar to asymmetric stock market reactions. Although there is no study which for-
mally examines the reasons of differential responses from stock investors and stock analysts,
Ederington and Goh (1998, 570) provide two potential explanations for this asymmetry: “ . . .
i) companies voluntarily release favorable information but are reluctant to release unfavorable
information, or ii) the rating agencies expend more resources in detecting deteriorations in
credit quality than improvements”. Both explanations, particularly the first one, suggest that
there is more information available to stock analysts prior to upgrades than prior to downgrades.
As a result, stock analysts’ responses are stronger to downgrades than upgrades.5
2.1. Reg. FD and the change in information environment for stock analysts
Examining the period prior to enactment of Reg. FD (from 1984 to 1990), Ederington and Goh
(1998) find evidence that stock analysts revise their earnings forecasts in response to rating
changes. One plausible interpretation of this evidence is that CRAs enjoy an information advan-
tage over equity analysts and that this advantage existed even in the pre-Reg. FD era, when both
stock analysts and CRAs presumably had unfettered access to corporate management. However,
an alternative interpretation is that the information sets of CRAs and stock analysts are correlated
and they react to new earnings information in a consistent manner, resulting in a positive associ-
ation between ratings changes and earnings forecast revisions.
Enactment of Reg. FD provides a unique opportunity to distinguish between these two
alternative explanations because it has fundamentally altered the information environment by
6 B. Jung et al.
eliminating stock analysts’ private access to corporate managements. Indeed, Arya et al. (2005)
argue that the overall level of firm disclosure to the market may decline following Reg. FD.6
Because CRAs are exempt from Reg. FD’s restrictions on obtaining private information, any
information advantage that CRAs might have had relative to equity analysts could only have
increased post-Reg. FD. Consequently, if equity analysts were paying attention to rating
changes prior to Reg. FD, it is reasonable to posit that they would do so to a greater extent
after Reg. FD.
On the other hand, evidence in Mohanram and Sunder (2006) call this into question,
suggesting that equity analysts have compensated for the loss of private access to management
in the post-Reg. FD era by increasing their information gathering activities.7 In addition, there
is evidence that Reg. FD has had little or no impact on the accuracy and dispersion of analysts’
earnings forecasts (e.g. Heflin et al. 2003, Francis et al. 2006). Thus, it is also plausible that the
information contained in rating changes may already be impounded in stock analysts’ earnings
forecasts.8 If this is true, we should not observe any differential revision in analysts’ earnings fore-
casts subsequent to ratings changes between pre- and post-Reg. FD. Specifically, we test the fol-
lowing hypothesis (stated in the alternate form):
Hypothesis 1: Relative to the pre-Reg. FD period, the effect of credit rating changes on stock analysts’
earnings forecast revisions is stronger in the post-Reg. FD period.
2.2. Information uncertainty for stock analysts

Information uncertainty makes forecasting a difficult exercise. The amount of information uncer-
tainty is likely to differ across firms because of inherent differences in business conditions. Stock
analysts following firms with higher information uncertainty are more likely to seek other sources
of information in order to improve their forecasts (Zhang 2006b). Therefore, to the extent that
credit rating changes convey earnings-relevant information not already public, they should be
more useful to stock analysts facing greater information uncertainty, all else equal. On the
other hand, if analysts can predict earnings fairly accurately from the information available to
them, they will rely less on other sources of information. We thus expect that analyst forecast revi-
sions will be more sensitive to credit rating changes for firms with higher information uncertainty.
This leads to our second hypothesis (stated in the alternate form):
Hypothesis 2: The effect of credit rating changes on stock analysts’ earnings forecast revisions is
stronger for firms with higher information uncertainty.
Moreover, in light of prior evidence that upgrades contain relatively less information than down-
grades (Ederington and Goh 1998), and that there is more information uncertainty with respect to
bad news (Ertimur 2003), we expect Hypothesis 2 will hold more strongly for downgrades than
for upgrades.
We use two measures for the extent to which stock analysts face information uncertainty:
analyst forecast dispersion (DISP) and the number of analysts following a firm (ANA_FOL).
Prior studies employ analyst forecast dispersion to measure uncertainty related to earnings fore-
casts (e.g. Imhoff and Lobo 1992, Barron et al. 1998). Alford and Berger (1999) document a posi-
tive relation between analyst following and analyst forecast accuracy, suggesting that higher
analyst coverage results in a better information environment. Roulstone (2003) provides evidence
that analyst following proxies for the amount of public information available in the market.
Higher (lower) analyst forecast dispersion or lower (higher) analyst following thus represents
higher (lower) levels of information uncertainty.
3. Data, sample selection, and descriptive statistics

3.1. Data and sample selection
We collect bond rating changes from Fixed Income Securities Database (FISD), which includes
basic characteristics of each bond issue such as maturity, security level, convertibility, offering
date, and offering amount. This database contains rating history since April 1995 from S&P,
Moody’s, Duff and Phelps, and Fitch. The initial sample consists of all bond rating changes
between April 1995 and December 2006.9 Following prior studies (e.g. Jorion et al. 2005), we
delete rating changes related to ‘M&A activities’ and ‘market conditions’ from our sample,
since these events could contaminate the information contained in rating changes. We focus on
US domestic taxable corporate bonds, eliminating Yankee bonds, issues denominated in a
foreign currency, bonds issued through private placement, and convertible bonds. Since subsidi-
ary and subordinated debt of the same firm result in duplicate rating changes of senior debt, we
delete these observations as well. When rating changes are applied to multiple bond issues of the
same issuer on the same date, we keep only the issue with the largest rating change, since this
issue appears to affect stock price the most (Jorion et al. 2005). The number of remaining
rating changes is 15,750.
Financial data to construct our main variables are drawn from the Compustat quarterly data-
base. Stock price and return data are from CRSP. Data on analysts’ earnings forecasts are drawn
from the I/B/E/S detail file. These data restrictions of Compustat, CRSP, and I/B/E/S significantly
reduce the sample size to 2833 rating changes.10 Our sample size is further reduced to 2473 rating
changes because of deletions to mitigate concern that our results may be driven by other corporate
events rather than rating change announcements.11 First, we remove rating changes if they are
announced at the same date as earnings announcements and management earnings forecasts,
since they are significant events that are likely to trigger earnings forecast revisions irrespective
of information from rating change announcements. Second, we eliminate firms with stock price
less than $1 because such firms tend to experience downgrades associated with default announce-
ments or bankruptcy filings, and thus, these events may lead to extreme earnings forecast revi-
sions (Goh and Ederington 1999). In addition, stock price less than $1 may unduly affect
variables such as earnings forecast revision and analyst forecast dispersion because they are
deflated by stock price. Third, we exclude extreme rating changes where the absolute magnitude
of rating change is greater than 5, because most of these rating changes are associated with bank-
ruptcy filings (e.g. Enron, Winstar Communications, Delta Air Lines, and Delphi).
Since our analysis is at the analyst level, we compute earnings forecast revision for each
analyst issuing earnings forecasts both before and after a rating change announcement. For earn-
ings forecasts before a rating change announcement, we eliminate observations if analysts do not
have one-year-ahead earnings forecasts at least 90 days prior to bond rating change announce-
ments.12 To capture the information content of rating changes for stock analysts, we use a
seven-day cut-off point after rating change announcements. If analysts do not issue earnings fore-
casts within seven days after a rating change, we record a forecast revision of zero. We include
these zero forecast revisions in our tests, because analysts may perceive the rating changes as
unimportant or their current forecasts may already reflect similar information.13 Our choice of
a seven-day cut-off point is based on our observation that on average, at least one stock
analyst revises her earnings forecast within seven days after a rating change.14 This seven-day
cut-off point ensures that our sample includes earnings forecasts with higher forecast immediacy,
which is the speed with which stock analysts react to public release of new information (Mozes
2003).15 Our final sample consists of 2473 rating change announcements, with 23,486 corre-
sponding earnings forecast revisions. In Table 1, Panel A, we summarize our sample selection
procedure described above.
8
Table 1. Sample Development and Credit Ratings Definition
Panel A: Sample Selection Process
The number of rating change
Selection Criteria observations
Bond rating upgrades and downgrades between April 1995 and December 2006, excluding: upgrades and downgrades which are 117,528 rating changes
due to mergers and acquisitions and market conditions; Yankee bonds; issues which are denominated in a foreign currency;
bonds issued through private placement; issues which can be converted to common stock; subsidiary and subordinated debt;
non-taxable corporate bonds.
Issues with the largest magnitude of rating change. 15,750 rating changes
Availability of data from COMPUSTAT and CRSP. 4632 rating changes
Availability of data from I/B/E/S detailed and summary files. 3904 rating changes
Availability of all of the following variables: firm size, leverage, ROA, Altman Z-score, analyst forecast dispersion and earnings 2833 rating changes
change in the prior quarter.
Changes remaining after excluding rating change observations where: rating changes are announced at the same date as 2473 rating changes
B. Jung et al.
management earnings forecasts and earnings announcement dates; firms have stock price less than $1; and the absolute
magnitude of rating changes is greater than 5.
Final sample of rating change-earnings forecast observations with all one-year-ahead earnings forecasts available. 23,198 observations
Panel B: Ratings definition
Description Standard & Poor’s Moody’s Service Fitch Service Duff & Phelps Cardinal Scale
Investment grade
Highest grade AAA Aaa AAA AAA 1
High grade AA (+, none, 2) Aa (1,2,3) AA (+, none, 2) AA (+, none, 2) 2,3,4
Upper medium grade A (+, none, 2) A (1,2,3) A (+, none, 2) A (+, none, 2) 5,6,7
Medium grade BBB (+, none, 2) Baa (1,2,3) BBB (+, none, 2) BBB (+, none, 2) 8,9,10
Non-investment Grade
Lower medium grade BB (+, none, 2) Ba (1,2,3) BB (+, none, 2) BB (+, none, 2) 11,12,13
Speculative B (+, none, 2) B (1,2,3) B (+, none, 2) B (+, none, 2) 14,15,16
Poor standing CCC (+, none, 2) Caa (1,2,3) CCC (+, none, 2) CCC 17,18,19
Highly speculative CC (+, none, 2) Ca CC 20
Lower quality, no interest C C C 21
In default D DDD/DD/D DD 23
Panel B of Table 1 describes our coding system for credit ratings. We assign the variable RTG
a cardinal number for each rating category, starting with the highest (i.e. the most favorable) rating
(Jorion et al. 2005). For example, ratings of Aaa for Moody’s and AAA for S&P, Fitch, and Duff
and Phelps are the highest grade categories respectively, so RTG equals1 for firms with those
ratings. In a similar manner, RTG equals 2 for ratings of Aa1 by Moody’s and AA+ by S&P,
Fitch, and Duff and Phelps, which are their second-highest grade categories. Thus, a higher
(lower) value for RTG indicates a less (more) favorable credit rating. An increase (decrease) in
rating, captured in DRTG indicates a rating downgrade (upgrade).
3.2. Descriptive statistics

Descriptive statistics are reported in Table 2. In Panel A, each observation represents a tuple con-
sisting of a rating change and corresponding earnings forecast revision by an analyst. We report
the number of rating changes as well as the number of rating change – earnings forecast revision
tuples by year. The total number of downgrades (upgrades) is 1697 (776) while the number of
rating change– earnings forecast revision tuples is 14,948 (8250) for downgrades (upgrades).
The number of downgrades increased from 1996 to 2001 and then decreased. There is no
trend in the number of upgrades.
Panel A also shows the mean earnings forecast revision (REVISIONi,j,t) for both downgrades
and upgrades by year.16 We calculate REVISIONi,j,t as (Fi,j,t – Fi,j,t21)∗ 100/P ∗ i, where, Fi,j,t is the
first one-year ahead earnings forecast issued by stock analyst j after a rating change announcement
for firm i. Fi,j,t21 is the last one-year ahead earnings forecast issued by the same stock analyst j
prior to a rating change for firm i. P ∗ is the stock price per share six months prior to a rating
change (Ederington and Goh 1998). On average, REVISION following downgrades is 20.235
and significant at the 1% level. In most years, the mean of REVISION following downgrades
is significantly negative. The mean of REVISION following upgrades is 0.003 and significant
at 1% level while it is significantly positive (at p , 0.01) in only 4 out of 11 years.17 The absolute
magnitude of REVISION is much higher for downgrades than upgrades (0.235 vs. 0.003), con-
sistent with stronger stock market reaction to downgrades than upgrades. However, the standard
deviation of REVISION is also higher for downgrades than for upgrades (1.1884 vs. 0.2481),
indicating that analysts’ responses to downgrades, although stronger, exhibit higher variation.
Recall that DRTG captures the magnitude of a rating change, with a positive (negative) value
of DRTG indicating a downgrade (upgrade) per the coding system for credit ratings in Panel B of
Table 1. On average, the absolute magnitude of downgrades is significantly higher than that of
upgrades (1.48 vs. 21.25). Table 2, Panel A also shows that the mean of REVISION following
downgrades is dramatically more negative after Reg. FD. However, DRTG for downgrades also
becomes more positive after Reg. FD, suggesting that the change in forecast revisions after Reg.
FD may be driven by the larger magnitude of downgrades. This implies that it is important to
control for rating change characteristics (such as the magnitude of the change) to test the hypoth-
esis that Reg. FD enhances information advantage of CRAs relative to stock analysts. There is no
clear trend in the mean REVISION subsequent to upgrades.
Table 2, Panel B presents descriptive statistics on variables used in our empirical analysis.
CROSS is a dummy variable that indicates bond ratings which are downgraded (upgraded)
from investment (speculative) to speculative (investment) grade. About 14% of both downgrades
and upgrades cross between speculative and investment grades. SPEC equals 1 for rating changes
within speculative grades and 0 otherwise. Approximately 30% (40%) of downgrades (upgrades)
are within speculative grades. LOG(DAYS) is the natural log of the number of days between con-
secutive rating changes in the same direction (i.e. downgrade after downgrade or upgrade after
upgrade). If two consecutive ratings changes are not in the same direction, we set DAYS equal
10
Table 2. Descriptive statistics.

Panel A: The frequency and magnitude of bond rating changes (¼DRTG) and earnings forecast revision (¼REVISION) by year
Downgrades Upgrades
The number of observations The number of observations
for rating change-stock for rating change-stock
analyst {The number of analyst {The number of
observations for rating Mean Mean observations for rating Mean Mean
B. Jung et al.
Year change} REVISION p-value DRTG change} REVISION p-value DRTG
1996 31 {1} 20.0600 0.3590 1.0000 110 {10} 20.0013 0.3555 21.3091
1997 539 {61} 20.1048 0.0017 1.2690 725 {70} 20.0107 0.0263 21.1807
1998 731 {81} 20.0592 ,0.0001 1.3269 684 {76} 20.0356 0.0097 21.1520
1999 1105 {129} 20.0994 ,0.0001 1.3910 409 {47} 0.0028 0.8965 21.0465
2000 1395 {176} 20.3754 ,0.0001 1.4860 600 {49} 0.0182 0.0010 21.4483
2001 2739 {317} 20.2217 ,0.0001 1.5798 375 {42} 0.0001 0.9863 21.2987
2002 2620 {273} 20.3458 ,0.0001 1.5683 305 {34} 0.0206 0.0127 21.2951
2003 1530 {183} 20.3666 ,0.0001 1.4497 691 {66} 0.0234 0.0012 21.1766
2004 1280 {144} 20.1453 ,0.0001 1.3891 1292 {104} 0.0056 0.3966 21.2585
2005 1273 {149} 20.2941 ,0.0001 1.5224 1276 {114} 0.0146 0.0673 21.3809
2006 1705 {183} 20.0859 ,0.0001 1.4317 1783 {164} 20.0000 0.9700 21.1980
Total 14948 {1,697} 20.2352 ,0.0001 1.4789 8250 {776} 0.0034 ,.0001 21.2490
Panel B: Descriptive Statistics for Downgrades and Upgrades

Downgrades (N = 14,948) Upgrades (N = 8,250)
th
Variable Mean ST.DEV. 25 Median 75th Mean ST.DEV. 25th Median 75th
REVISION 20.2352 1.1884 0.0000 0.0000 0.0000 REVISION 0.0034 0.2481 0.0000 0.0000 0.0000

DRTG 1.4789 0.8211 1.0000 1.0000 2.0000 DRTG 21.2490 0.7104 21.0000 21.0000 21.0000
CROSS 0.1456 0.3527 0.0000 0.0000 0.0000 CROSS 0.1430 0.3501 0.0000 0.0000 0.0000
SPEC 0.2996 0.4581 0.0000 0.0000 1.0000 SPEC 0.4016 0.4902 0.0000 0.0000 1.0000
LOG(DAYS) 4.6109 2.1958 2.9444 4.7185 7.0901 LOG(DAYS) 5.5100 1.9572 4.4427 6.2442 7.0901
SIZE 9.0702 1.1668 8.2926 9.1838 9.9608 SIZE 8.8707 1.1232 8.0594 8.9656 9.8096
PRE_CAR 20.0954 0.7414 20.2126 20.0158 0.1239 PRE_CAR 0.0805 0.4818 20.0611 0.0254 0.1728
PRE_DEARN 20.0177 0.1755 20.0216 20.0017 0.0087 PRE_DEARN 0.0009 0.0237 20.0030 0.0011 0.0056
PRE_REVISION 20.0169 0.7720 0.0000 0.0000 0.0000 PRE_REVISION 20.0038 0.3772 0.0000 0.0000 0.0000
FREQ_REVISION 1.8631 1.2567 1.0000 2.0000 2.0000 FREQ_REVISION 1.7663 1.1679 1.0000 1.0000 2.0000
DIFF_REVISION 36.1050 24.4195 15.0000 32.0000 55.0000 DIFF_REVISION 35.9901 24.2291 14.0000 32.0000 55.0000
NEG_OUTLOOK 0.1943 0.3957 0.0000 0.0000 0.0000 POS_OUTLOOK 0.0602 0.2380 0.0000 0.0000 0.0000
DIFF_EARN_DATE 51.2663 27.1578 28.0000 51.0000 72.0000 DIFF_EARN_DATE 49.4566 25.7549 28.0000 49.0000 70.0000
FD 0.7808 0.4137 1.0000 1.0000 1.0000 FD 0.7070 0.4552 0.0000 1.0000 1.0000
LEV 0.3664 0.2364 0.1667 0.3266 0.5276 LEV 0.2271 0.1772 0.0909 0.1840 0.3129
Z-score 1.2635 1.1912 0.4194 1.0857 1.8196 Z-score 2.1387 2.0499 0.9729 1.6597 2.8283
ANA_FOL 15.6012 7.3591 10.0000 15.0000 21.0000 ANA_FOL 18.5479 8.1717 13.0000 18.0000 24.0000
DISP 0.0151 0.0372 0.0015 0.0040 0.0114 DISP 0.0045 0.0070 0.0009 0.0018 0.0052
ROA 20.0036 0.0320 20.0100 0.0032 0.0122 ROA 0.0171 0.0185 0.0088 0.0172 0.0275
LOSS 0.3958 0.4890 0.0000 0.0000 1.0000 LOSS 0.0995 0.2994 0.0000 0.0000 0.0000
Note: All variables are defined in the appendix.
11
12 B. Jung et al.
to 1200 days, following Jorion et al. (2005). Both the mean and the median of LOG(DAYS) are
significantly greater for upgrades than for downgrades, implying that a downgrade is more likely
to be followed by another downgrade.
Our empirical models also consider whether downgrades (upgrades) are accompanied with
negative (positive) outlooks or rating reviews. In many cases, rating outlooks are released at
the same time as rating changes and signal the likely direction of ratings changes in next six
months to two years. According to Standard and Poor’s (2009), S&P changes a rating and
places the revised rating on outlook for a further review when it believes that a further change
might be merited in the near future. Rating outlooks thus supplement information provided in
the credit rating, and allow CRAs to address criticism that ratings are not timely, without increas-
ing the volatility of credit ratings. NEG_OUTLOOK (POS_OUTLOOK) is equal to 1 if a down-
grade (upgrade) is accompanied by a negative (positive) outlook or review and 0 otherwise.18
More than 19% of downgrades are accompanied by negative outlooks or rating reviews. Positive
outlooks are less prevalent than negative outlooks; only 6% of upgrades are announced with posi-
tive outlooks or rating reviews.19
FD indicates whether a rating change belongs to the pre- or post-Reg. FD period. Approxi-
mately 78% (71%) of downgrades (upgrades) are announced in the post-Reg. FD period. Down-
graded firms are more leveraged (37%) than upgraded firms (23%) when leverage (LEV) is
computed as long-term debt divided by the sum of market value of equity plus long-term debt.
Z-score represents Altman’s (1968) Z-score, which is computed as 1.2∗ working capital/total
assets + 1.4∗ retained earnings/total assets + 3.3∗ income before extraordinary items/total assets
+ 0.6∗ shares outstanding∗ price/total liabilities + sales/total assets. A higher Z-score indicates
lower default risk. ANA_FOL is measured as the number of stock analysts following a firm.
On average, downgraded (upgraded) firms are followed by approximately 16 (19) stock analysts,
indicating that analyst coverage of firms with downgrades is lower than analyst following with
upgrades. Analyst forecast dispersion (DISP) is higher for downgrades (0.0151) than for upgrades
(0.0045), indicating that information environment before downgrades is more uncertain. As
expected, return on assets (ROA) for downgraded (upgraded) firms is negative (positive). Simi-
larly, loss occurrence (LOSS) is higher in downgraded firms than upgraded firms (40% vs. 10%).
4. Empirical tests and results

4.1. Earnings forecast revisions to bond rating changes
The following model (1) provides the basis for examining effects of rating change characteristics
(i.e. DRTG, CROSS, and SPEC) on earnings forecast revisions, REVISION. Model (1) is similar
to the model in Jorion et al. (2005), which examines stock market reactions to rating changes. We
estimate model (1) separately for downgrades and upgrades.
REVISION = a0 + a1 DRTG + a2 CROSS + a3 SPEC

+ a4 LOG(DAYS) + a5 SIZE + a6 PRE CAR
+ a7 PRE DEARN + a8 PRE REVISION + a9 FREQ REVISION (1)
+ a10 DIFF REVISION + a11 OUTLOOK + a12 DIFF EARN DATE
+ Industry dummies + Year dummies + 1.
All variables are also summarized in the appendix.

Because a rating change across multiple grades is likely to include additional information and
DRTG is positive (negative) for a downgrade (upgrade), we expect the coefficient of DRTG to be
negative for both downgrades and upgrades. Prior studies (e.g. Goh and Ederington 1999, Jorion
et al. 2005, Jorion and Zhang 2007) find that downgrades from investment to non-investment
grade (CROSS) or those within non-investment grade (SPEC) generate larger negative stock
returns than those within investment grade. We thus predict negative coefficients of both
CROSS and SPEC for downgrades. Similarly, we expect positive coefficients of CROSS and
SPEC for upgrades. We also include the following variables in model (1):
LOG(DAYS): Captures how informative a rating change is relative to its prior rating
change. If LOG(DAYS) is large, each rating change is more likely to
provide new information to analyst earnings forecasts, but there is
also increased potential for confounding events between the two rating
changes that may decrease the information content of the subsequent
rating change.
PRE_REVISION: The last earnings forecast revision prior to a rating change. This controls
for any news publicly released after the previous ratings change but
before the analyst’s forecast prior to the new ratings change, because
we would expect the analyst’s prior forecast to subsume this infor-
mation. In addition, it would reflect any advance knowledge the
analyst may have of the information contained in a subsequent ratings
change.
PRE_CAR: Cumulative market-adjusted returns (using value-weighted market
returns) over the window from the last earnings forecast revision date
before a rating change to date t21, where day t is a rating change
date. This controls for any news publicly released after the analyst’s
forecast prior to the ratings change, but prior to the three-day event
window surrounding the ratings change.20
PRE_DEARN: Quarterly earnings change prior to a rating change. This controls for the
possibility that earnings forecast revisions after rating changes could
represent a lagged reaction to information incorporated in earnings
announcements rather than rating changes.
SIZE: Reflects a firm’s information environment (Collins and Kothari 1989,
Zhang 2006a).
FREQ_REVISION: The number of earnings forecast revisions before a rating change for 90
days for each analyst.
DIFF_REVISION: Difference in days between the last earnings forecast revision and a
rating change announcement.
DIFF_EARN_DATE: Difference in days between earnings announcement date and earnings
forecast revision date. This controls for the possible effect of increasing
pessimism of earnings forecasts prior to the earnings announcement date
(Richardson et al. 2004).
OUTLOOK: Indicator for whether a rating change is accompanied by an outlook or
rating review (NEG_OUTLOOK for negative outlooks or reviews, or
POS_OUTLOOK for positive outlooks or reviews, for downgrades
and upgrades, respectively).
The OUTLOOK variable allows us to examine whether stock analysts respond more strongly
to ratings changes with outlooks than those without, in which case the coefficient for NEG_OUT-
LOOK in the model for downgrades would be negative and the coefficient for POS_OUTLOOK
in the model for upgrades would be positive. Finally, we include industry and year dummies to
14 B. Jung et al.
control for variation in earnings forecast revisions across industries and over years. We compute
standard errors clustered by both firm and analyst to mitigate concerns that the residuals may be
correlated (Petersen 2009).21
Results for downgrades (upgrades) are reported in Panel A (Panel B) of Table 3. Panel A
shows that, consistent with our expectation, the coefficient of DRTG is significantly negative
for downgrades. We also find that both coefficients of CROSS and SPEC are significantly
negative for downgrades, indicating more pronounced analyst responses to downgrades
crossing from investment to non-investment grade and those within non-investment grades.
For upgrades in Panel B, both coefficients of DRTG and SPEC are insignificant. However,
consistent with our expectation, the coefficient of CROSS is significantly positive at 10%
level (p-value ¼ 0.074).
Turning to control variables, for downgrades, the coefficient of NEG_OUTLOOK is signifi-
cantly negative, suggesting that earnings forecast revisions are more negative for downgrades
with negative outlooks than those unaccompanied by negative outlooks, and that rating
outlook is informative to stock analysts’ earnings forecasting activities. However, we are not
able to reject the null that the coefficient of POS_OUTLOOK in the model for upgrades equals
zero; thus, there appears to be no difference in stock analysts’ response between upgrades
accompanied by positive outlooks and those without positive outlooks.22
As noted earlier, the literature generally documents that a downgrade is more likely to
provide new information than an upgrade (Ederington and Goh 1998). Research in other
areas supports this notion. Kothari et al. (2009) examine stock returns prior to news announce-
ments (e.g. dividend changes and management earnings forecasts) and show that a greater frac-
tion of news is impounded in stock prices prior to good news relative to bad news, suggesting
that good news tends to be leaked to the market, whereas managers tend to withhold much of
the bad news from investors. We perform a similar analysis and find the same pattern. For
downgrades, average cumulative market-adjusted returns (using value-weighted market
returns) before a rating downgrade (from t230 to t22, where t indicates a rating announce-
ment) are 23.5% while average stock returns around a rating downgrade announcement
(from t21 to t+1) are 22.2%. For upgrades, average stock returns from t230 to t22 are
2% while stock returns around an upgrade announcement are 0.4%. As the results show, a
greater fraction of good news is already impounded in stock prices before a rating upgrade
announcement.
4.2. Impact of information environment on the association between rating changes and
earnings forecast revisions
Overall, the results in Table 3 suggest that stock analysts respond to rating changes and that the
nature of the rating change is informative. For downgrades, the forecast revision is significantly
associated with the magnitude of the change (DRTG), whether the rating change causes the firm to
cross into the speculative grade (CROSS), or if the rating is changed within the speculative grade
(SPEC). For upgrades, only CROSS is significantly associated with forecast revisions. We next
look at whether and how rated firms’ information environments impact the way that equity ana-
lysts use the information in rating changes.
In Hypothesis 1, we conjecture that if Reg. FD discourages communication of private infor-
mation between stock analysts and management, with the result that CRAs have a greater infor-
mation advantage after Reg. FD, then stock analysts will rely more on rating changes for their
earnings forecasts after Reg. FD. Thus, we predict that stock analysts’ response to rating change
characteristics such as DRTG, CROSS, or SPEC will differ significantly between the pre- and
post-Reg. FD periods. Specifically, we expect that the coefficients of DRTG, CROSS, or SPEC
Table 3. Earnings forecast revisions to bond rating change announcements.

REVISION ¼ a0 + a1DRTG + a2CROSS + a3SPEC + a4LOG(DAYS) + a5SIZE + a6PRE_CAR + a7PRE_DEARN + a8PRE_REVISION +
a9FREQ_REVISION + a10DIFF_REVISION + a11OUTLOOK + a12DIFF_EARN_DATE + Industry dummies + Year dummies + 1
Panel A: Downgrades Panel B: Upgrades
Variable Predicted sign Coefficient p-value Variable Predicted sign Coefficient p-value

Intercept 0.6741 ,.0001 Intercept 20.0566 0.1665
DRTG 2 20.0277 0.0567 DRTG 2 0.0017 0.7848
CROSS 2 20.1606 ,.0001 CROSS + 0.0136 0.0738
SPEC 2 20.2538 ,.0001 SPEC + 0.0014 0.8863
LOG(DAYS) 0.0018 0.6883 LOG(DAYS) 20.0005 0.6623
SIZE 20.0352 0.0003 SIZE 0.0054 0.1067
PRE_CAR 0.0839 ,.0001 PRE_CAR 0.0064 0.1368
PRE_DEARN 0.4310 0.0006 PRE_DEARN 0.4921 0.7031
PRE_REVISION 0.0147 ,.0001 PRE_REVISION 0.0080 0.2615
FREQ_REVISION 20.0810 ,.0001 FREQ_REVISION 0.0010 0.7094
DIFF_REVISION 20.0032 ,.0001 DIFF_REVISION 0.0001 0.4804
NEG_OUTLOOK 20.1065 0.0003 POS_OUTLOOK 20.0072 0.5532
DIFF_EARN_DATE 20.0001 0.8231 DIFF_EARN_DATE 20.0001 0.5462
Industry and year dummies YES Industry and year dummies YES
Adj. R2 (%) 5.25% Adj. R2 (%) 0.95%

N 14948 N 8250
Notes: The results of estimating the following regressions of analyst earnings forecast revision (REVISION) on various bond rating change characteristics. All variables are defined in the
appendix. All t-tests are two-tailed. All standard errors are corrected for both firm-level and analyst-level clustering.
15
16 B. Jung et al.
for downgrades will be more negative in the post-Reg. FD period. For upgrades, we expect that the
coefficient of DRTG (CROSS or SPEC) will be more negative (positive) in the post-Reg. FD period.
To test Hypothesis 1, we add FD – a dummy variable for Reg. FD – and its interactions with DRTG,
CROSS, or SPEC to the model (1) and estimate the following model (2):
REVISION = a0 + a1 DRTG + a2 CROSS + a3 SPEC

+ a4 LOG(DAYS) + a5 SIZE + a6 PRE CAR
+ a7 PRE DEARN + a8 PRE REVISION + a9 FREQ REVISION
+ a10 DIFF REVISION + a11 OUTLOOK + a12 DIFF EARN DATE
+ a13 FD + a14 FD∗DRTG + a14 FD∗CROSS + a15 FD∗SPEC
+ Industry dummies + Year dummies + 1, (2)
where all variables are as previously defined and summarized in the appendix.
Referring to Panel A of Table 4, all the coefficients of FD∗ DRTG, FD∗ CROSS, and FD∗ SPEC
are significantly negative for downgrades, supporting our hypothesis that stock analysts’ response
to downgrades are more negative in the post-Reg. FD period than in the pre-FD period. The coef-
ficients of DRTG and CROSS are not significant, while only the coefficient of SPEC is signifi-
cantly negative, indicating that in the pre-FD period, stock analysts were not relying on rating
changes for information to a great extent, except for those within speculative grades. Results
for upgrades in Panel B show that all the coefficients of FD∗ DRTG, FD∗ CROSS, and
FD∗ SPEC are insignificant, failing to support Hypothesis 1 for upgrades.
Ederington and Goh (1998) also examine the association between forecast revisions and
ratings changes in the pre-FD period. Our study differs in two important respects. First, Edering-
ton and Goh (1998) focus on consensus earnings forecasts and do not fully control for information
available to individual stock analysts prior to bond rating changes. In contrast, our tests are at the
individual stock analyst level and control for public information available to stock analysts.
Second, Ederington and Goh (1998) do not consider characteristics of rating changes, such as
the magnitude of the change (DRTG), whether the rating change causes the firm to cross into
the speculative grade (CROSS), or if the rating is changed within the speculative grade
(SPEC). Our results indicate that these variables are significant in terms of explaining the associ-
ation between downgrades and earnings forecast revisions. In addition, the significantly negative
coefficient on SPEC does indicate that downgrades within speculative grades are informative to
stock analysts, even prior to Reg. FD.23
4.3. Information uncertainty and earnings forecast revisions after debt rating changes
In Hypothesis 2, we predict that stock analysts are more likely to utilize information from rating
changes for earnings forecasts when forecasting earnings is more difficult. Specifically, we
examine whether the effect of rating changes on earnings forecast revisions is less pronounced
for firms with a better information environment, such as higher analyst coverage or lower
analyst forecast dispersion. To test this, we estimate the model (2) after replacing FD with
HIGH_ANA_FOL and LOW_DISP, respectively. HIGH_ANA_FOL (LOW_DISP) is equal to
1 if analyst following (analyst forecast dispersion) is greater (lower) than the sample median
and 0 otherwise. Again, higher (lower) analyst coverage (analyst forecast dispersion) indicates
a better information environment.
Panel A in Table 5 reports results using analyst coverage as the measure of the information
environment. The coefficients of DRTG, CROSS, and SPEC are all significantly negative for
Table 4. The effect of FD on the association between rating change characteristics and earnings forecast revisions.
REVISION ¼ a0 + a1DRTG + a2CROSS + a3SPEC + a4LOG(DAYS) + a5SIZE + a6PRE_CAR + a7PRE_DEARN + a8PRE_REVISION +
a9FREQ_REVISION + a10DIFF_REVISION + a11OUTLOOK + a12DIFF_EARN_DATE + a13FD + a14FD∗ DRTG + a14FD∗ CROSS +

a15FD∗ SPEC + Industry dummies + Year dummies + 1
Panel A: Downgrades Panel B: Upgrades
Variable Pred. sign Coefficient p-value Variable Pred. sign Coefficient p-value

DRTG 2 0.0186 0.2822 DRTG 2 20.0029 0.6094
CROSS 2 0.0411 0.3939 CROSS + 20.0065 0.6980
SPEC 2 20.0996 0.0900 SPEC + 0.0036 0.7808
LOG(DAYS) 0.0024 0.6040 LOG(DAYS) 20.0005 0.6606
SIZE 20.0313 0.0015 SIZE 0.0058 0.0750
PRE_CAR 0.0841 ,.0001 PRE_CAR 0.0070 0.1048
FD 0.1432 0.0037 FD 20.0212 0.3242
FD∗ DRTG 2 20.0529 0.0272 FD∗ DRTG 2 0.0057 0.5293
FD∗ CROSS 2 20.2477 0.0002 FD∗ CROSS + 0.0259 0.1339
FD∗ SPEC 2 20.1846 0.0046 FD∗ SPEC + 20.0036 0.7993
Adj. R2 (%) 5.39% Adj. R2 (%) 1.00%
N 14948 N 8250
Notes: The results of estimating the following regression of analyst earnings forecast revision (REVISION) on bond rating change characteristics (i.e. DRTG, CROSS, and SPEC) and
their interactions with FD. All variables are defined in the appendix. All t-tests are two-tailed. All standard errors are corrected for both firm-level and analyst-level clustering.
17
18
Table 5. The effect of information uncertainty on the association between rating change characteristics and earnings forecast revisions.
Panel A: Analyst following
REVISION ¼ a0 + a1DRTG + a2CROSS + a3SPEC + a4LOG(DAYS) + a5SIZE + a6PRE_CAR + a7PRE_DEARN + a8PRE_REVISION + a9
FREQ_REVISION + a10DIFF_REVISION + a11OUTLOOK + a12DIFF_EARN_DATE + a13HIGH_ANA_FOL + a14HIGH_ANA_FOL
∗
DRTG + a14 HIGH_ANA_FOL∗ CROSS + a15 HIGH_ANA_FOL∗ SPEC + Industry dummies + Year dummies + 1
Downgrades Upgrades
B. Jung et al.
DRTG 2 20.0446 0.0235 DRTG 2 0.0049 0.2960
CROSS 2 20.3160 ,.0001 CROSS + 0.0214 0.0701
SPEC 2 20.2700 ,.0001 SPEC + 0.0049 0.6014
LOG(DAYS) 0.0019 0.6743 LOG(DAYS) 20.0005 0.6228
SIZE 20.0573 ,.0001 SIZE 0.0071 0.0945
PRE_CAR 0.0878 ,.0001 PRE_CAR 0.0061 0.1368
HIGH_ANA_FOL 20.0296 0.4650 HIGH_ANA_FOL 0.0059 0.5640
HIGH_ANA_FOL∗ DRTG + 0.0485 0.1006 HIGH_ANA_FOL∗ DRTG + 20.0066 0.5107
HIGH_ANA_FOL∗ CROSS + 0.3592 ,.0001 HIGH_ANA_FOL∗ CROSS 2 20.0175 0.2909
HIGH_ANA_FOL∗ SPEC + 0.0432 0.4272 HIGH_ANA_FOL∗ SPEC 2 20.0080 0.6040
Adj. R2 (%) 5.70% Adj. R2 (%) 0.99%
N 14948 N 8250
Panel B: Analyst forecast dispersion
FREQ_REVISION + a10DIFF_REVISION + a11OUTLOOK + a12DIFF_EARN_DATE + a13LOW_DISP + a14LOW_DISP∗ DRTG +
a14LOW_DISP∗ CROSS + a15 LOW_DISP∗ SPEC + Industry dummies + Year dummies + 1

Downgrades Upgrades
DRTG 2 20.0373 0.0634 DRTG 2 20.0019 0.8273

CROSS 2 20.1175 0.0356 CROSS + 0.0046 0.8492
SPEC 2 20.2033 ,.0001 SPEC + 20.0075 0.6935
LOG(DAYS) 20.0010 0.8310 LOG(DAYS) 20.0005 0.6654
SIZE 20.0314 0.0012 SIZE 0.0059 0.0976
PRE_CAR 0.0768 ,.0001 PRE_CAR 0.0065 0.1351
PRE_REVISION 0.0128 0.0002 PRE_REVISION 0.0080 0.2575
LOWDISP 0.0977 0.0031 LOWDISP 0.0111 0.4880
LOWDISP∗ DRTG + 0.0502 0.0162 LOWDISP∗ DRTG + 0.0089 0.4362
LOWDISP∗ CROSS + 0.0002 0.9970 LOWDISP∗ CROSS 2 0.0137 0.6067
LOWDISP∗ SPEC + 0.1375 0.0045 LOWDISP∗ SPEC 2 0.0198 0.2909
Adj. R2 (%) 5.78% Adj. R2 (%) 1.02%
N 14948 N 8250
their interactions with HIGH_ANA_FOL and LOW_DISP. HIGH_ANA_FOL (LOW_DISP) is equal to 1 if ANA_FOL (DISP) is greater (lower) than the sample median. All variables
are defined in the appendix. All t-tests are two-tailed. All standard errors are corrected for both firm-level and analyst-level clustering.
19
20 B. Jung et al.
the group of firms with lower analyst coverage. We are not able to reject the null that the coef-
ficients of interaction terms HIGH_ANA_FOL∗ DRTG and HIGH_ANA_FOL∗ SPEC are
equal to zero. Thus, we fail to detect any difference in the association between forecast revi-
sion and rating change for firms with high and low analyst following; we also do not find any
difference in this association when the rating change is confined to being within speculative
grades. However, the coefficient of HIGH_ANA_FOL∗ CROSS is significantly positive for
downgrades, and we cannot reject the null that the net coefficient for CROSS equals zero
(i.e. HIGH_ANA_FOL∗ CROSS + CROSS ¼ 0.043, p ¼ 0.154). This result suggests that
the effect of downgrades on earnings forecast revisions is lower for firms followed by more
stock analysts. Hypothesis 2 is not supported for upgrades, however. The coefficients of
HIGH_ANA_FOL∗ DRTG, HIGH_ANA_FOL∗ CROSS, and HIGH_ANA_FOL∗ SPEC are all
insignificant.
Table 5, Panel B reports results based on earnings forecast dispersion as a proxy for infor-
mation uncertainty. The effects of DRTG, CROSS, and SPEC on earnings forecast revisions
are all significantly negative for firms with higher earnings forecast dispersion. For down-
grades, the coefficients of LOW_DISP∗ DRTG and LOW_DISP∗ SPEC are significantly posi-
tive, supporting our hypothesis that the association between rating change characteristics and
earnings forecast revisions is less pronounced for firms with lower earnings forecast dis-
persion i.e. for firms with better information environments. However, we are not able to
reject the null that the coefficient of LOW_DISP∗ CROSS equals zero. That is, after account-
ing for the effect of the magnitude of the rating change, downgrades from investment grade
to speculative grade categories per se do not affect forecast revisions. Again for upgrades, all
coefficients of LOW_DISP∗ DRTG, LOW_DISP∗ CROSS, and LOW_DISP∗ SPEC are
insignificant.
Taken together, the two panels in Table 5 provide support to Hypothesis 2 for downgrades but
not for upgrades.
5. Supplementary analyses
5.1. Impact of leverage and default risk on the association between rating changes and
earnings forecast revisions
A ratings change is arguably only as important to equity and credit markets as the debt itself is
to the firm. If debt constitutes a small portion of a firm’s capital structure such that future inter-
est cost is relatively insignificant, current and future credit issues should not be of high infor-
mational importance to stock analysts.24 An upgrade (downgrade) is likely to be viewed more
positively (negatively) by stock analysts when leverage is higher, because such a rating change
communicates an upward (downward) revision in a company’s ability to cover future interest
cost, which is positively related to leverage. Similarly, we argue that a rating change is more
important to firms with higher default risk because the impact of a rating change on future
interest cost is greater for firms with higher default risk. There may also be implications of
rating changes for debt contracts with performance pricing, where interest charged on a
bank loan is a function of the borrowers’ current credit rating or other measures of perform-
ance (Asquith et al. 2005).
We use leverage and default risk (as measured by Altman’s Z-score) to explore their effects on
the association between ratings changes and forecast revisions. Specifically, we estimate model
(2) after replacing FD with HIGH_LEV and LOW_Z. HIGH_LEV (LOW_Z ) is equal to 1 if lever-
age (Altman’s Z-score) is greater (lower) than the sample median and 0 otherwise. A higher
Altman’s Z-score indicates lower default risk.
Results are presented in Table 6, Panel A (for leverage) and Panel B (for Altman’s Z-score). In
Panel A, for downgrades, we find that the coefficients of HIGH_LEV∗ CROSS and HIGH_LEV∗-
SPEC are significantly negative, consistent with our conjecture. This result suggests that the effect
of downgrades on forecast revisions is greater for firms with higher leverage and that downgrades
are more informative for stock analysts following firms that are more reliant on debt. The effect of
the magnitude of the rating change on forecast revision appears to be similar for both high- and
low-leverage firms, as indicated by the insignificant coefficient of the interaction term HIGH_-
LEV∗ DRTG. Results for Altman’s Z-score in Panel B for downgrades are similar to those with
leverage, albeit weaker. Only the coefficient of LOW_Z∗ SPEC is significantly negative, implying
that for downgrades, stock analysts appear to glean more information from rating changes of firms
with higher default risk. In sum, these results support our conjecture for downgrades. Results for
upgrades do not support our hypothesis. When leverage is used in Panel A, all the coefficients of
HIGH_LEV∗ DRTG, HIGH_LEV∗ CROSS, and HIGH_LEV∗ SPEC are not significant. Results
for upgrades are similar when we employ Altman’s Z-score in Panel B.
5.2. Credit rating data limitation

Bongaerts et al. (2012) document that due to changes in the FISD data collecting procedures, the
FISD rating information before 2000 is incomplete. In particular, many bond issues before 2000
have missing S&P ratings. Since the pre-/post- Reg. FD timeline almost exactly overlaps with the
timing of FISD’s inconsistency in data collecting procedure, it is possible that our results may be
affected by this data availability issue. To mitigate the concern that there is some systematic bias
in the ratings available before 2000, we replicate our results after eliminating S&P credit rating
downgrades (which reduces our sample size to 8663 observations). Results (untabulated) are sub-
stantially similar to our main results, ruling out the possibility that our results are biased by FISD’s
inconsistency in data collecting procedure. We also re-estimate our models except for model (2)
after eliminating all downgrade observations prior to 2000. Again, results (untabulated) are quali-
tatively similar, and are inconsistent with the idea that our results are biased due to changes in the
FISD data collecting procedures.
5.3. Impact of other regulatory changes around Reg. FD

Reg. FD occurred when there were many other events shaping the business environment in
general and CRAs in particular. For example, the Enron crisis was a significant event because
of its general impact on the business environment and resulting increase in scrutiny of CRAs.
Cheng and Neamtiu (2009) examine the impact of SOX on CRAs, and find that due to increased
regulatory pressure and investor criticism for lack of timeliness, after SOX, CRAs have not only
improved rating timeliness, but also have increased rating accuracy and reduced rating volatility.
The Global Settlement is another important regulatory change which impacts stock analysts’
output (Barniv et al. 2009). It focuses on the optimistic bias in analyst earnings forecasts and
stock recommendations. This change in the nature of analyst forecasts likely has an impact on
how credit ratings are reflected in earnings forecast revisions. Therefore, it is possible that our
results on Reg. FD are affected by other regulatory events and may thus be biased.25 To mitigate
this concern, we re-estimate model (2) after controlling for the effects of regulatory changes such
as SOX and the Global Settlement. Results (untabulated) with these additional control variables
are generally similar to those in Table 4. Specifically, for downgrades, both coefficients of
FD∗ DRTG and FD∗ CROSS are still significantly negative, suggesting that our results on Reg.
FD do not seem to be driven by those events. Results for upgrades are also similar to those
reported in Table 4.
22
Table 6. The effect of future interest cost on the association between rating change characteristics and earnings forecast revisions.
Panel A: Leverage
FREQ_REVISION + a10DIFF_REVISION + a11OUTLOOK + a12DIFF_EARN_DATE + a13HIGH_LEV + a14HIGH_LEV∗ DRTG + a14
HIGH_LEV∗ CROSS + a15HIGH_LEV∗ SPEC + Industry dummies + Year dummies + 1
Downgrades Upgrades
B. Jung et al.
DRTG 2 20.0045 0.7005 DRTG 2 0.0033 0.2068
CROSS 2 20.0785 0.0151 CROSS + 0.0184 0.0854
SPEC 2 20.0112 0.7646 SPEC + 0.0079 0.1994
LOG(DAYS) 0.0010 0.8247 LOG(DAYS) 20.0004 0.7482
SIZE 20.0376 0.0001 SIZE 0.0056 0.0955
PRE_CAR 0.0833 ,.0001 PRE_CAR 0.0065 0.1375
HIGH_LEV 0.0003 0.9929 HIGH_LEV 20.0016 0.9449
HIGH_LEV∗ DRTG 2 20.0306 0.1845 HIGH_LEV∗ DRTG 2 20.0030 0.8417
HIGH_LEV∗ CROSS 2 20.1054 0.0794 HIGH_LEV∗ CROSS + 20.0181 0.4488
HIGH_LEV∗ SPEC 2 20.2573 ,.0001 HIGH_LEV∗ SPEC + 20.0144 0.5148
Adj. R2 (%) 5.52% Adj. R2 (%) 0.98%
N 14948 N 8250
Panel B: Altman’s Z score
FREQ_REVISION + a10DIFF_REVISION + a11OUTLOOK + a12DIFF_EARN_DATE + a13LOW_Z + a14 LOW_Z∗ DRTG +
a14LOW_Z∗ CROSS + a15LOW_Z∗ SPEC + Industry dummies + Year dummies + 1

Downgrades Upgrades
DRTG 2 20.0101 0.4956 DRTG 2 0.0027 0.2611

CROSS 2 20.1559 ,.0001 CROSS + 0.0105 0.2862
SPEC 2 0.0354 0.2387 SPEC + 0.0026 0.7893
LOG(DAYS) 0.0020 0.6661 LOG(DAYS) 20.0005 0.6601
SIZE 20.0327 0.0008 SIZE 0.0054 0.1702
PRE_CAR 0.0834 ,.0001 PRE_CAR 0.0066 0.1431
LOW_Z 0.0482 0.1353 LOW_Z 20.0041 0.8339
LOW_Z∗ DRTG 2 20.0127 0.6101 LOW_Z∗ DRTG 2 20.0019 0.8910
LOW_Z∗ CROSS 2 20.0326 0.6173 LOW_Z∗ CROSS + 0.0110 0.6361
LOW_Z∗ SPEC 2 20.3563 ,.0001 LOW_Z∗ SPEC + 20.0009 0.9566
Adj. R2 (%) 5.50% Adj. R2 (%) 0.96%
N 14948 N 8250
their interactions with HIGH_LEV and LOW_Z. HIGH_LEV (LOW_Z ) is equal to 1 if LEV (Z-score) is greater (lower) than the sample median. All variables are defined in the appendix.
All t-tests are two-tailed. All standard errors are corrected for both firm-level and analyst-level clustering.
23
24 B. Jung et al.
Our inferences would significantly benefit if we could find a potential control group of firms
not subject to Reg. FD. While American depository receipts (ADRs) are likely candidates because
they are exempt from Reg. FD (Rule 243.101(b)), the sample size would be small. To be included
in our sample, ADRs firms would have to be covered in both FISD (for bond rating change
announcements) and I/B/E/S (for earnings forecasts). In addition, as Koch et al. (2013) indicate
(p. 633), given conflicting results in the prior studies using ADRs, the appropriateness of ADRs as
controls is not clear.
Alternatively, we can use pre-Reg. FD levels of selective disclosure to provide a control (Koch
et al. 2013). However, this may also be ineffective. Bushee et al. (2004) find that the proportion of
firms discontinuing conference calls and changing policies is small, and they do not find a differ-
ence in the information content of conference calls between pre- and post-Reg. FD. Similarly,
Mensah and Yang (2008) attempt to use the number of press conferences held prior to Reg.
FD as a control, but they do not detect any difference between firms that had many versus few
press conferences prior to Reg. FD.
5.4. Confounding events around rating changes

Our models in Section 4 include control variables such as PRE_CAR, PRE_REVISION, and
PRE_DEARN to mitigate the potential impact of correlated omitted variables (e.g. any underlying
news events) on our results. To mitigate concern about the effect of confounding events on our
results, following the literature (e.g. Jorion et al. 2005), we search corporate events not captured
by our previous screening through Wall Street Journal Abstracts. We consider a rating change as
contaminated if there are other events between t21 and t+1, where t is a rating change date. We
replicate our analysis without these contaminating observations (approximately 30% of our
sample). Results (untabulated) based on uncontaminated observations are qualitatively
unchanged.26
5.5. Revisions of two-year-ahead earnings forecasts

Our primary tests employ one-year-ahead earnings forecasts because we believe that for most
firms, one-year-ahead earnings represent a realistic horizon to reflect the change in real costs
due to rating changes.27 In addition, our use of one-year-ahead earnings forecasts is consistent
with the prior literature (e.g. Ederington and Goh 1998). As a sensitivity test, we also use two-
year-ahead earnings forecasts. Untabulated results based on two-year-ahead earnings forecasts
are weaker, but generally similar to our main results in Section 4.28
6. Conclusion
Information dissemination in bond markets and resulting implications for financial reporting and
equity pricing are topics that have received considerable interest from both researchers and prac-
titioners (Holthausen and Leftwich 1986, Dichev and Piotroski 2001, SEC 2003, Norden and
Weber 2004, Jorion and Zhang 2007). In particular, CRAs have emerged as significant infor-
mation intermediaries. CRAs have considerable access to corporate management – access that
has become increasingly restricted for other market participants, following enactment of Reg.
FD, particularly for stock analysts. CRAs thus are a potentially important source of information
to market participants, including equity analysts.
We study how stock analysts use information contained in debt ratings for their earnings fore-
casts. We find that in addition to characteristics of the rating changes, the information environ-
ment affects the way that debt rating changes are incorporated into stock analysts’ earnings
forecasts. We also find that stock analysts view the information contained in ratings differently for
upgrades versus downgrades. In particular, our results suggest that stock analysts glean infor-
mation from the magnitude of ratings changes, whether they are within speculative versus invest-
ment grade, and whether the rating changes cross between investment and speculative grade.
Moreover, the change in information environment due to Reg. FD and information uncertainty
affect the association between rating downgrades and stock analysts’ earnings forecast revisions.
Collectively, our results increase our understanding of whether and when equity analysts use debt
ratings as a source of information.
Our analysis and results are subject to a few caveats. First, because of the nature of the bond
ratings data, our measure of the rating changes is necessarily ordinal. A limitation of such a
measure is that a change in rating from AAA to AA+ is likely to have different implications
for analysts than a change from A2 to BBB+, and movement across broad rating categories
may have different implications than movement with rating categories (Jung et al. 2013).
While we have tried to account for changes across categories and changes within a category
by incorporating variables such as CROSS and SPEC, some measurement error is inevitable.
Our measure of analyst forecast is also subject to measurement error. In particular, we have com-
puted this revision using the forecast issued within a period of seven days following a debt rating
change as the revised forecast. To the extent that this forecast does not fully incorporate the infor-
mation contained in the debt rating change, our measure biases our analysis against finding
support to our hypotheses. While we checked the robustness of our results to alternate specifica-
tions, some arbitrariness cannot be avoided. Finally, we lack a suitable control group to evaluate
the impact of Reg FD on the association between rating changes and forecast revisions. In
Section 5.3, we discuss this limitation and attendant issues.
In addition to our current enquiry, it would be interesting to examine the effect of information
environment on the association between rating changes and earnings forecast revisions in other
countries since information environments and the effectiveness of Reg. FD would be different
in each country. For example, in South Korea, a regulation very similar to the US Reg. FD
became effective on 1 November 2002, including the clause that CRAs were granted a similar
exemption from the regulation as in the USA. It would be interesting to compare our results
with those based on Korean Reg. FD to investigate its effectiveness. We leave this avenue to
future research.
Acknowledgements
The authors thank Steve Rock, Phil Shane, Sunny Yang, Han Yi, and workshop participants at the University
of Colorado at Boulder and the 2006 American Accounting Association annual meeting (Washington, DC)
for their helpful comments. The authors also thank Nate Staheli for his excellent research assistance.
Disclosure statement
No potential conflict of interest was reported by the authors.
Notes
1. Reg. FD, effective 23 October 2000, barred US public firms from disclosing non-public material infor-
mation to select groups such as stock analysts and institutional investors. CRAs have not been affected
because of an exemption under 17CFR 243.100(b)(2)(iii) during our sample period (Jorion et al. 2005).
2. Indeed, Mohanram and Sunder (2006) provide evidence that analysts likely increase their information
gathering efforts post Reg. FD to compensate for the loss of private access to management.
26 B. Jung et al.
3. In addition to credit ratings, CRAs also provide rating outlooks to indicate their view regarding the
potential direction of a long-term credit rating over the intermediate term (typically six months to
two years) (Altman and Rijken 2005, Standard and Poor’s 2009). Thus, rating outlooks supplement
the information in the credit rating. We find that stock analysts respond more strongly to downgrades
with negative outlooks compared to downgrades without them. We do not find any significant differ-
ence for upgrades.
4. Due to regulatory constraints, some institutions (e.g. insurance companies and pension funds) are
sometimes prohibited from holding debt securities rated as speculative. If credit ratings are down-
graded from investment to speculative grade, these organizations must immediately sell their
investments.
5. To test explanations by Ederington and Goh (1998), we perform an analysis similar to Kothari et al.
(2009) for dividend changes and management earnings forecasts. We explain the results in Section 4.
6. Arya et al. (2005) develop their model from the standpoint of herding behavior of analysts. Mensah
and Yang (2008) fail to find an increase in herding behavior following Reg. FD, but cannot reject
the Arya et al. model because they cannot control for financial or career motives of analysts that
may dominate the information cascade effect posited in the model (Mensah and Yang 2008, p. 318).
7. Bagnoli et al. (2008) support the notion of a change in analyst strategies following Reg. FD. They find
that after Reg. FD, the most successful analysts (measured by designation as All-Americans by Insti-
tutional Investor) were less dependent on privileged communication.
8. In this case, the observed market reaction to subsequent ratings changes may be attributed to a “con-
firmatory effect”. In our empirical tests, we control for information contained in prior forecast revisions
in examining the association between ratings changes and contemporaneous earnings forecast
revisions.
9. We believe that it would be interesting to look at the data after 2007, particularly during the financial
crisis. However, we do not include this sample period for two reasons. First, with respect to our main
results regarding the effect of Reg. FD on the association between rating changes and earnings forecast
revisions, if we include more recent years, there would be too many confounding events. In addition,
CRAs’ and stock analysts’ incentives and behaviors are likely different during the financial crisis
versus normal times.
10. Our sample size appears small compared to that of Jorion et al. (2005). Their sample consists of 2204
rating changes from 1998 to 2002. Our sample size differs because: (1) Jorion et al. (2005) do not use I/
B/E/S database for their empirical analysis and (2) our models include financial variables derived from
Compustat, such as leverage and Altman’s Z-score, which reduce our sample further. Prior to these
requirements, our sample consists of 4632 rating changes. When we replicate Jorion et al. (2005),
our sample size is similar to theirs.
11. Our results are qualitatively similar without these deletions.
12. Our choice of 90 days is arbitrary. To justify our choice, we attempt to calculate how often each stock
analyst issues one-year ahead earnings forecasts on average. Based on I/B/E/S earnings forecast data
from 1984 to 2006, we find that on average, analysts issue one-year-ahead earnings forecasts about
every 100 days. The choice of a window longer than 100 days would therefore be inappropriate,
because it is plausible that analysts consider their earnings forecast revision following the rating
change not because of the information in the rating change, but simply because of the timing for
new earnings forecasts. Thus, we choose a 90-day window. Our results do not qualitatively differ
when we use 30, 60, or 180-day windows.
13. Our results are qualitatively similar when we delete zero earnings forecast revisions. The numbers of
observations with non-zero earnings forecast revision (zero earnings forecast revision) are 2530
(12,418) and 681 (7569) for downgrades and upgrades, respectively.
14. The mean is calculated based on earnings forecasts for 30 days after rating changes. The mean is 7.155,
while the median is 4. Its standard deviation is 8.08.
15. The choice of cut-off point for earnings forecasts after a rating change announcement is not straight-
forward. With a very short cut-off point such as three days, we can further mitigate the effect of con-
founding events on our results. However, this time period may be too short for stock analysts to
interpret and incorporate information from rating changes into earnings forecast revisions. On the
other hand, if we use a longer cut-off point such as beyond 30 days, the sample is more likely to
include earnings forecasts affected by information other than rating changes. Therefore, as sensitivity
analyses, we also use 3, 5, 10, and 30 days instead of the 7-day cut-off point. Our results are qualitat-
ively similar for these alternative cut-off points.
16. Our final sample contains no observations for 1995.
17. Equity analysts may revise their earnings forecasts after a downgrade for two reasons: (1) the down-
grade provides some useful private information about operating performance to equity analysts and (2)
the downgrade leads to future higher borrowing costs which, in turn, affect a firm’s future profitability
and trigger a revision in earnings forecasts. To investigate the two explanations, similar to Chandra and
Nayar (1998), we examine the effect of rating downgrades on sales forecast revisions instead of earn-
ings forecast revisions. Using sales forecasts can be helpful since sales are not directly related to inter-
est expense (Chandra and Nayar 1998). When we use sales forecasts, the sample size is significantly
reduced, however. For example, for downgrades, the number of observations is only 4521. Results
with sales forecasts are generally similar to those based on earnings forecasts, confirming that analysts
perceive rating downgrades as an indicator of lower future operating performance as well as indication
of future higher borrowing cost. Given our focus on the effect of information environment on the
association between rating changes and earnings forecast revisions, however, it does not really
matter which explanation dominates. For example, if the information environment is strong, stock ana-
lysts would obtain information on an increase in future borrowing cost prior to the credit rating change
announcements, resulting in a weaker association between rating changes and earnings forecast revi-
sions. The same logic can be applied to information on future operating performance.
18. For accuracy, we manually double-check whether the information from the FISD is consistent with
information from Rating Action by Moody’s. The two sources are consistent for most rating
changes in our sample. Specifically, we randomly select 50 rating changes which are announced by
Moody’s from our sample in the FISD. We find that 46 out of 50 are consistent with those from
Rating Action by Moody’s.
19. Examples of outlooks from Rating Action (by Moody’s) and RatingsDirect (by S&P) are: (1)
“Moody’s downgrades AES corporation to Ba3. Rating remains under review for possible further
downgrade” (27 June 2002) and (2) “S&P downgrades SunTrust Banks Inc. (NYSE) to ’BBB+’
from ’A.’ Outlook is negative” (28 April 2009).
20. Note that any publicly announced news event before the ratings change during days t21 and t (t being
the day of the ratings change) poses a problem in examining whether equity analysts glean any
additional information from the ratings change. An implicit assumption underlying this issue is that
rating agencies respond almost instantaneously to new information. However, Katz et al. (2009)
cite corporations such as Enron, WorldCom, and Parmalat to observe that rating agencies do not
respond quickly to market events. Moreover, as documented in the literature (Altman and Rijken
2005), CRAs are known to revise their ratings deliberately and only periodically.
21. To control for the effects of extreme values, we winsorize observations at the top and bottom 1% of
their distributions except for DRTG and indicator variables such as CROSS and SPEC.
22. It is plausible that statistical power for the test of upgrades is low because we have only 26 upgrades
with a positive outlook.
23. The effect of rating changes on earnings forecast revisions prior to Reg. FD appears weak in our
sample, which seems to be inconsistent with Ederington and Goh’s (1998) results. To show that our
results prior to Reg. FD are not inconsistent with Ederington and Goh (1998), we follow their research
design by using consensus earnings forecasts instead of individual stock analyst’ earnings forecasts.
Since their results in Table 2 are the most relevant to reconcile the difference between two results,
we replicate their results reported in Panel A of Table 2 (p. 574) with our sample of rating changes
in the pre-FD period. Please note that our sample period even prior to Reg. FD is quite different
from their sample period, which is from 1984 to 1990. Thus, it is not plausible to exactly replicate
their results since their sample periods are not available in the FISD database, which starts covering
rating changes from 1995. Nonetheless, consistent with the findings in Ederington and Goh (1998),
we document that earnings forecast revision after downgrades is significantly negative in the month
of rating change (p-value , 0.001; coefficient ¼ 20.78) in our sample prior to Reg. FD. These
results suggest that rating changes are informative prior to Reg. FD in our sample. Note that the coeffi-
cient in Ederington and Goh (1998) is 20.70 and significant (p-value , 0.001).
24. According to the literature (e.g. Ashbaugh-Skaife et al. 2006) and corporate ratings criteria issued by
S&P (e.g. Standard and Poor’s 2005), the most important risk factors for credit ratings are interest cov-
erage and leverage.
25. See Pope and McLeay (2011) for a discussion of this point in the context of the introduction of IFRS.
26. For downgrades, the following interacted variables of our interest are significant at least at 10% level
with the same signs as reported in Tables 4–6: FD∗ CROSS, FD∗ SPEC, HIGH_ANA_FOL∗ DRTG,
HIGH_ANA_FOL∗ CROSS, LOWDISP∗ SPEC, HIGH_LEV∗ SPEC, and LOW_Z∗ SPEC. These
results are available upon request.
28 B. Jung et al.
27. We do not examine forecasts of next quarter earnings because the time period is too short to sufficiently
reflect changes in real costs.
28. We do not examine earnings forecasts relating to longer periods than two years (e.g. three-year-ahead
and four-year-ahead earnings forecasts) because of sample size considerations.
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Appendix 1. Variables definitions.
REVISIONi,j,t ¼ earnings forecast revision which is computed as (Fi,j,t – Fi,j,t21)∗ 100/P∗ i, where, Fi,j,t is the first
one-year ahead earnings forecast (i.e. FY1) issued by analyst j after a rating change announcement for firm i from
the I/B/E/S detail file. Fi,j,t21 is one-year ahead earnings forecast issued by analyst j prior to a rating revision
announcement. P∗ is the price per share one month prior to a rating change, which is retrieved from the CRSP.
DRTG ¼ the magnitude of a rating change (i.e. a cardinal value of new rating – a cardinal value of old
rating). Refer to Panel B, Table 1 for detail about cardinal values of credit ratings.
CROSS ¼1 if a bond rating is downgraded (upgraded) from investment (non-investment) grade to non-
investment (investment) grade, and 0 otherwise. An investment grade is defined as at least a BBB rating
offered by Standard & Poor’s or Fitch Service or DP or a Baa rating offered by Moody’s. Operationally,
a rating is coded as an investment grade if cardinal scale of the rating is less than 10. See Panel B, Table
1 for more detail.
SPEC ¼ 1 if a bond rating is changed within non-investment grade and 0 otherwise.
LOG(DAYS) is the natural log of the number of days since a previous rating change in the same direction.
‘DAYS’ is computed as the number of days between two subsequent rating changes in the same direction
30 B. Jung et al.
(i.e. downgrade after downgrade or upgrade after upgrade). If two subsequent ratings changes are not in the
same direction, following Jorion et al. (2005) we set DAYS equal to 1200.
SIZE ¼ the logarithm of total assets (Compustat item ATQ) in the prior quarter to a rating change announcement.
PRE_CAR ¼ cumulative market-adjusted returns (using value-weighted market returns) over the window
from the last earnings forecast date prior to rating change announcement to the day t21, where day t is a
rating change announcement date.
PRE_DEARN is actual quarterly earnings change (Compustat item IBQ/item ATQ) in the prior quarter to a
rating change announcement.
PRE_REVISION is the last analyst earnings forecast revision that occurred prior to a rating change
announcement.
FREQ_REVISION is the number of earnings forecast revision that occurred prior to a rating change
announcement over 90 days for each stock analyst.
DIFF_REVISION ¼ the difference in days between prior earning forecast date to bond rating change and
rating change announcement date.
NEG_OUTLOOK ¼ 1 if a downgrade is announced with negative outlooks or rating reviews and

0 otherwise.
POS_OUTLOOK ¼ 1 if an upgrade is announced with positive outlooks or rating reviews and 0 otherwise.
DIFF_EARN_DATE ¼ the difference in days between prior earnings announcement date to rating change
announcement and prior earnings forecast revision date to rating change announcement.
FD ¼ 1 if a bond rating change is announced in the post-FD period (defined as dates after October 2000) and
0 otherwise (pre-FD period).
ENRON ¼ 1 if a bond rating change is announced after 2 December 2001 and 0 otherwise.
SOX ¼ 1 if a bond rating change is announced after 21 July 2002 and 0 otherwise.
GLOBAL ¼ 1 if a bond rating change is announced after 28 April 2003 and 0 otherwise.
LEV ¼ Long-term debt divided by the sum of long-term debt and market value of equity in the prior quarter
to a rating change announcement (¼ Compustat item DLTTQ/(item PRCCQ∗ item CSHOQ + item
DLTTQ)).
Z-score ¼ Altman’s Z-score, which is computed as 1.2∗ working capital (Compustat item ACTQ – item
LCTQ)/total assets (item ATQ) + 1.4∗ retained earnings (item REQ)/total assets + 3.3∗ income before extra-
ordinary items (item IBQ)/total assets + 0.6∗ shares outstanding∗ price (item CSHOQ∗ item PRCCQ)/total
liabilities (item LTQ) + 1∗ sales (item REVTQ)/total assets in the prior quarter to a rating change
announcement.
ANA_FOL ¼ the number of analysts following a firm. It is measured one month prior to a bond rating
change.
DISP ¼ analyst forecast dispersion which is computed one month prior to a rating change

n
2 ∗
i=1 (Fi − F) /n − 1 /P , where Fi is the analyst i’s forecast, F is the mean forecast, n is the
¼
number of forecasts, and P∗ is the stock price one month prior to a rating change announcement.
ROA ¼ return on assets (¼ Compustat item IBQ/item ATQ)
LOSS ¼ 1 if ROA is negative and 0 otherwise.

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