The Interpretive Information Content of Credit Ratings Changes for Stock Investors

Prior studies document significant abnormal stock returns contemporaneous with ratings changes. These findings suggest that ratings changes have information content. It is commonly assumed that stock investors use ratings changes to predict future performance, but in this study we investigate the possibility that investors use ratings changes to reinterpret previously released information (i.e., credit ratings changes have interpretive information content). The interpretive information content could arise from ratings changes either confirming or disconfirming previously released information (e.g., earnings announcements). Confirming ratings changes are upgrades (downgrades) that follow previous good (bad) news. Disconfirming ratings changes are upgrades (downgrades) that follow previous bad (good) news. We investigate whether credit ratings changes have interpretive information content and if so, whether the interpretive information content is weaker for firms with strong information environments. For confirming ratings changes we find, consistent with our prediction, a positive association between announcement returns and previously released information. For disconfirming ratings changes we find, also consistent with our prediction, a negative association between announcement returns and previously released information. The associations are generally weaker for firms with strong information environments. Our results provide new insights into the usefulness of credit ratings changes to the stock market and have important implications for firms’ information environments.