THE ROLE OF OPERATING CASH FLOW IN CREDIT RATING: INVESTMENT-GRADE FIRMS VS. SPECULATIVEGRADE FIRMS

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Abstract

Despite Standard and Poor’s long-standing claim that cash flow is a critical aspect of its rating decisions, the credit rating literature has failed to document a significant relation between credit rating and cash flow measures. A possible explanation of this discrepancy is that the rating agency weighs
operating cash flow differently between investment-grade and speculative-grade issuers. Performing an ordered probit analysis of a panel of firms from 1989 to 2006, we find operating cash flow is positively associated with credit ratings for speculative-grade issuers, but not for investment-grade issuers. In contrast, accrual-based earnings are found to be positively associated with credit ratings,
but only for investment-grade firms. Our study thus solves a discrepancy between industry documents and the academic literature.

Keywords: Credit Rating, Accounting Quality, Value Relevance, Distress

How to cite this paper: Wang, X.(F.), Zhang, J., & Zhang, W. S. (2012). The role of operating cash flow in credit rating: Investment-grade firms vs. speculative grade firms. Risk Governance and Control: Financial Markets & Institutions, 2(2), 48-63. https://doi.org/10.22495/rgcv2i2art3