Initial Public Debt Issues and Accompanying Corporate Behavior

We examine a company’s decision to issue public debt for the first time by analyzing its behavior around the time of obtaining its first debt rating. Contrary to our expectations, we find that firms are more likely to pay dividends in the years prior to the initial rating rather than at or after the announcement date, and that the amount of dividend payments actually appears to decline (rather than increase). We posit that this may be attributable to the fact that firms initiate and/or increase dividend payments in anticipation of accessing the public debt markets for the first time. This behavior leads us to consider other actions that firms might undertake in preparation for this event. We go on to find that firms’ stock prices fall in the period following their initial debt rating. Further, there is strong evidence that earnings drop afterwards. We argue that these observations are consistent with the fact that firms “time” their decision to access public debt markets to follow periods of strong share price and earnings performance. This leads us to consider the possibility that companies may actively “manage” their earnings to make them appear as attractive as possible in the pre-rating period, and we find evidence to support this assertion. JEL Classification Codes: G35, G32