ABSTRACT
We examine the extent to which credit ratings affect firms’ cash holdings by investigating the circumstances in Korea after the 1997 Asian financial crisis. We find that, due to the costs and benefits associated with different rating levels, credit ratings are a major consideration for corporate cash management. Specifically, firms that become relatively sensitive to rating changes increase their cash holdings, either to improve the chances of an upgrade, or to avoid a downgrade. Furthermore,this effectis driven by chaebol business groups that increasingly rely on external financing that depends on credit ratings following the attenuation of their internal capital markets. Finally, we show that the impact of credit ratings on firms’ cash holdings is more noticeable when firms are more prominent in the market.
5. Conclusion
This paper examines the impact of credit ratings on corporate cash holdings by considering Korean firms following the 1997 Asian financial crisis. We find that credit ratings affect corporate cash management. The results of the regressions present evidence that, when firms become sensitive to rating changes (i.e., firms that experience rating changes to notch credit ratings), they increase their cash holdings. As a percentage of total assets, this increase is approximately 0.6% more than for firms that do not become sensitive (i.e., all other firms). This is consistent with the role of credit ratings as a major consideration in managers’ corporate policy decisions because of the costs and benefits driven by different rating levels. Further, we find that the statistically positive association between cash holdings and credit rating sensitivities is concentrated in chaebol firms. In particular, the increase of cash holdings in chaebol firms is approximately 0.9%, a finding that is consistent with the important role of credit ratings for chaebol groups because of the shrinkage of internal capital markets following the 1997 crisis. Lastly, we show that the credit rating effects analyzed in our chaebol samples are more noticeable when firms have more prominent positions in the market. In particular, the increased liquidity of investment-grade chaebol firms is approximately 0.8% and that of leading firms within chaebol groups is approximately 2.7%. These results support the idea that when firms receive more attention from market participants, they are more sensitive to the discrete costs and benefits driven by rating changes.
In sum, credit rating sensitivities affect firms’ cash policy decisions. Thus, our empirical findings have important implications for an understanding of corporate cash management in response to managers’ concerns about credit ratings.
