Abstract

We study the real effects of credit rating downgrades by exploring the exogenous variation on ratings that is due to the rating agencies ’ sovereign ceiling policies. Sovereign downgrades have a disproportional effect on the rating of firms whose rating is equal to or above the sovereign (bound firms). This asymmetric effect leads to greater reductions in investment and net debt issuance of bound firms relative to otherwise similar firms that are below the sovereign. Consistent with a contraction in debt supply, bond yields of bound firms increase more than yields of firms below the bound following a sovereign downgrade.