1. The Information Content of Initial Firm Rating Announcements Paper Presenter: Chih-Hsiang Chang Department of Finance National University of Kaohsiung

2. INTRODUCTION Information asymmetry exists in markets where sellers know more about product quality than buyers. The question of whether rating announcements convey information previously unknown to investors has long attracted research interest. While rating announcements can be for either initial ratings or rating changes, the majority of past studies have concentrated on the announcement effect of the latter.

3. INTRODUCTION (Cont.) Our study differs from previous research in at least two important aspects. We examine the market reaction to announcements of initial firm ratings, rather than debt ratings. This study establishes a theoretical framework to analyze the information content of initial ratings and should therefore yield more fruitful and plausible findings.

4. INFORMATION ASYMMETRY AND SEQUENTIAL SIGNALING How would the market respond to initial rating announcements? A high initial rating can induce negative reactions from the market just as likely as a low rating to draw positive responses. Potential buyers will then compare it against the average quality and adjust its market value accordingly.

5. INFORMATION ASYMMETRY AND SEQUENTIAL SIGNALING (Cont.) If stock price is lower than that if true quality is known to the market, we say its stock price is suffering a penalty premium due to information asymmetry. Firms have enough incentive to signal next, since its penalty premium will now be greater than the cost of signaling. sequential signal process

6. INFORMATION ASYMMETRY AND SEQUENTIAL SIGNALING (Cont.) When credit rating as a cost-effective signaling alternative becomes available, it is those marginal firms that will reap the most signaling benefit. Signaling through initial firm ratings thus can be more beneficial for smaller firms.

7. METHODOLOGY AND DATA Abnormal Returns and Initial Rating Announcements The standard market model The GARCH(1,1) model The three-factor model

8. METHODOLOGY AND DATA (Cont.)

9. Changes in Return Volatility Following Initial Rating Announcements

10. METHODOLOGY AND DATA (Cont.) Empirical Data A total of 118 firms (1997-2004) Our final sample thus consists of 74 companies that have received their first ever credit ratings. Trading data are collected from Taiwan Economic Journal (TEJ) database and Taiwan Economic Statistical Databank (TESD).

11. EMPIRICAL RESULTS

12. EMPIRICAL RESULTS (Cont.) This finding lends support to the proposition that the information content of initial firm rating announcements is more significant for smaller firms. We observe that the effect of initial rating announcement is fully reflected soon after the announcement day, suggesting that the stock price react rapidly to the information conveyed through initial ratings.

13. EMPIRICAL RESULTS (Cont.)

14. The positive stock price response to firms that receive low initial rating. Our findings should send a clear message to these firms that signaling through initial rating may be a sensible choice.

15. EMPIRICAL RESULTS (Cont.)

16. Initial rating announcements carry information value for smaller and lower quality firms in the market, but not for high quality ones. Initial ratings help reduce information asymmetry and induce the positive market response as evidenced by either higher stock prices or lower return volatility.

17. SUMMARY AND CONCLUSIONS Initial rating announcements help to reduce the penalty premium that has been imposed on their stock prices due to information asymmetry. The findings of this study have important implications for many small and low quality firms in the market.