This paper analyzes the effect of the downrating of the bonds, which become fallen angels, on the common shares of those firms. It tests two hypotheses namely 'the wealth transfer or redistribution hypothesis', and 'the information content hypothesis'...
This paper analyzes the effect of the downrating of the bonds, which become fallen angels, on the common shares of those firms. It tests two hypotheses namely 'the wealth transfer or redistribution hypothesis', and 'the information content hypothesis'. The wealth transfer hypothesis is based on the theory of transfer of wealth from the bondholders to the stckholders when the debt becomes riskier and hence, predicts an inverse effect on the stock returns due to the downrating of the bonds. On the other hand, the information content hypothesis predicts a direct relationship between the bond rating and the returns on the stock.
The evidence in this paper suggests that downgrading by Standard and Poor's and Moody's are associated with significant abnormal negative returns on one day before the announcement, whereas, the returns remained more or less, normal before and after this day. There are also implications that non-event related downratings conform to the information content hypothesis, the event related downratings of the bonds conform to the wealth transfer hypothesis, to a certain extend. But a more extensive study is required to be done, with a much larger sample size, in order to establish any significant results.