CREDIT RATINGS AND THE COST OF ISSUING SEASONED EQUITY

I am grateful for the invaluable comments and suggestions of Wayne Lee, Alexey Malakhov, Tim Yeager, Pu Liu, as well as to the seminar participants at the 2018 Financial Management Association Annual Meetings, the University of Arkansas and Boise State University. All errors remain my own. Abstract I examine the effects of issuer credit ratings on the costs associated with seasoned equity offerings (SEOs). The evidence from a panel of SEOs from 1990-2014 shows that when firms issue seasoned equity, those with issuer credit ratings pay reduced investment banking fees. I confirm these results by conducting a propensity matched sample comparison analysis of firms who obtain new, long-term issuer credit ratings to an unrated control group. Controlling for known determinants of SEO fees, I find that firms who obtain a new credit rating prior to issuing seasoned equity pay significantly reduced investment banking fees. In economic terms, underwriting fees for newly rated firms are 7.18% lower than those for similar, yet unrated firms. Finally, I examine the indirect costs of issuance and find some evidence that credit rated firms face reduced market-based costs to issue. Rated firms incur lower dilutionary costs to issue and have more positive abnormal returns surrounding the issue. model where the decision to become rated is modeled in the first step and an inverse Mills ratio is included in the second to control for in-sample bias. The reduction in fees is present after accounting for the potential bias resulting from the first-stage decision to become rated. Secondly, I examine how the association between credit ratings and fees changes across two levels of credit quality, i.e., investment-grade versus speculative-grade. I find that the benefits are most pronounced for investment-grade firms, but that both levels of credit quality exhibit a reduction in SEOs fees. This result is consistent with He, Wang, and Wei, (2010) who find that information asymmetry increases as credit ratings decline thus leading to a reduction in their value certainty. Finally, I employ a propensity-score, matched-sample approach wherein I identify previously unrated firms who obtain a credit rating and compare their SEO characteristics to an unrated, propensity-score matched control group. Controlling for the factors identified in prior literature as determinants of SEO issuance, I document an economically significant reduction of 7.18% in underwriting fees for newly rated firms, on average, and a 12.18% (5.89%) drop in underwriting fees for newly rated firms who receive an investment-grade (speculative-grade). In addition to documenting differences in underwriting costs for rated versus unrated firms, I explore the extent to which the indirect costs of SEO issuance, i.e., the market-based costs of SEO issuance, vary by the existence of an issuer credit rating. I find some evidence that the presence of a credit rating acts to reduce the market-based costs of issuance. Across a broad sample of SEOs, I find that dilutionary costs of SEO underpricing are reduced and abnormal returns surrounding the issue are more positive for issues by credit rated firms. the expanded regression specifications. The coefficient estimates on New Rating and New Investment Grade Rating and New Speculative Grade Rating are attenuated slightly but are qualitatively similar regardless of the inclusion of the additional covariates. Investment bank fees for SEO issuance are lower for credit rated firms controlling for other factors. The negative coefficient estimates on Shelf Registration provide further support for the findings of Gao and Ritter (2010) and Gustofson and Iliev (2017).