Wealth, leverage and crisis effects of the Malaysian corporate bond rating changes : an empirical investigation using event study methodology

Abstract

The main objective or this study is to examine the stock market reaction to various announcements by Rating Agency Malaysia (RAM) and the Malaysian Rating Corporation (MARC). The investigation involves testing the presence of the wealth effect following these announcements; examining whether the size of leverage matters in determining the extent of the market reaction to downgrades: testing whether the patterns of market reaction to each rating announcement have changed following the South East Asian financial crisis of the 1997/98 and evaluating the impact of corporate bond upgrades and downgrades on the yield premium. The stud) uses daily data for the stock returns for the period spanning from 1993 to 2003. and monthly data for the bond yields for the period that stretches from 1999 to 2003. Data were obtained from Rating Agency Malaysia (RAM) the Malaysian Rating Corporation (MARC). Bursa Malaysia (formerly, KLS[), Ne\v Straits Times (NST) database and Bank Negara Malaysia (f3NM). Abnormal returns are calculated using two statistical models under the framework of event study methodology. Namely. the OLS market model and the ARMA-GAR CH lag specification of the market model. On the other hand. the average differential yield premium is calculated using the method of differential yield premium (DYP). We find that. while corporate bond downgrades trigger a negative market reaction. upgrades du not. Significant fall in the wealth of shareholders is identified only ,with corporate bond downgrades. There arc some signs of information leakage in the market. We also find that for high leverage firms, a downgrade does not matter. However. for low leverage firms. a downgrade causes significant decline in returns. Downgrades post-crisis are less significant to the market as compared to downgrades pre-crisis. perhaps, due to the tighter disclosure requirements imposed by the Securities Commission following the crisis. The tests designed to uncover the implications of corporate bond rating changes to the efficiency of Bursa Malaysia implies that the market is efficient. Finally. we find that the yield premium increases significantly following corporate bond downgrades. However. following bond upgrades. the yield premium falls.