The authors examine the reaction of common stock returns to bond rating changes. While recent studies find a significant negative stock response to downgrades, they argue that this reaction should not be expected for all downgrades because some rating changes are anticipated by market participants and downgrades because of an anticipated move to transfer wealth from bondholders to stockholders should be good news for stockholders. The authors find that downgrades associated with deteriorating financial prospects convey new negative information to the capital market but that downgrades due to changes in firms' leverage do not.

We confirm prior evidence that bonds on average are offered at prices below their immediate post-offer secondary market prices. However, in cases where banks lead–manage their own bond offerings the underpricing is significantly less as compared with other non-self-marketed offerings. These findings are robust across various matched samples and selection models. Our results suggest that the bond offering process is characterized by substantive agency conflicts between shareholders of corporations (issuers) and underwriters.

We examine the effect of poison pill adoptions on firm value, controlling for the adopting firm's preexisting corporate governance structure. We find that only companies with the most democratic governance structures, defined as those with the fewest preexisting protective governance provisions, experience significantly positive abnormal stock returns and significantly positive abnormal revisions in five-year earnings growth rate forecasts. Moreover, regression results indicate that abnormal returns and forecast revisions are significantly related to governance structure and not to board composition or subsequent merger activity.

Both bond rating agencies and stock analysts evaluate publicly traded companies and com? municate their opinions to investors. Comparing the timeliness of each, we find that Granger causality flows both ways. While most bond downgrades are preceded by declines in actual and forecast earnings, both actual earnings and forecasts of future earnings tend to fall following downgrades. Although part of this post-downgrade forecast revision can be attributed to negative news regarding actual earnings, most appears to be reaction to the downgrade itself. We find little change in actual earnings following upgrades. Analysts, however, tend to increase their forecasts of future earnings.

Prior studies indicate that institutional investors are informed, in the sense that their trades predict price changes. In this study we show that return predictive ability of institutions arises (after controlling for size, book-to-market, and momentum) mainly from institutional sales of hard-to-value stocks during periods of positive market sentiment. These results support the notion that these stocks tend to be overvalued during periods of bullish market sentiment, and institutions contribute to market efficiency by identifying and trading on these overpriced stocks.

ABSTRACT We examine the reaction of common stock returns to bond rating changes. While recent studies find a significant negative stock response to downgrades, we argue that this reaction should not be expected for all downgrades because: (1) some rating changes are anticipated by market participants and (2) downgrades because of an anticipated move to transfer wealth from bondholders to stockholders should be good news for stockholders. We find that downgrades associated with deteriorating financial prospects convey new negative information to the capital market, but that downgrades due to changes in firms' leverage do not.

Payout policies based on share repurchase programs provide greater flexibility than do those based on cash dividends. We develop and test an empirical model in which strongly governed companies outperform weakly governed companies after announcing share repurchase programs. Our findings include positive associations between strong governance and both post-announcement adjusted operating performance and abnormal stock returns. The results are robust to sample selection bias, different sample criteria, governance measurement, and various control variables. In addition, governance strength is associated with larger post-announcement changes in CEO incentive compensation and merger and acquisition activity, both of which we argue are consistent with strongly governed companies using the financial flexibility derived from choosing share repurchases over cash dividends to drive better performance. Consistent with current literature on attenuation of former anomalies, the associations we find between governance and post-announcement performance tend to disappear in the latter half of our sample period.

We study earnings management (EM) efforts surrounding seasoned bond offerings using discretionary current accruals. We find that issuers tend to inflate earnings performance prior to an offering. In order for EM efforts to effectively mislead ratings agencies and the bond market, they must lead to inflated bond ratings and decreased offering yields. Regression results indicate the opposite; aggressive EM efforts are associated with lower initial ratings and higher offering yields. We also find a statistically lower proportion of subsequent downgrades for firms with the most aggressive EM efforts, which is inconsistent with these firms’ inflated initial ratings. While some firms may attempt to mislead ratings agencies and market participants by window-dressing earnings, these efforts appear to be counterproductive.

We study earnings management (EM) efforts surrounding seasoned bond offerings using discretionary current accruals. We find that issuers tend to inflate earnings performance prior to an offering. In order for EM efforts to effectively mislead ratings agencies and the bond market, they must lead to inflated bond ratings and decreased offering yields. Regression results indicate the opposite; aggressive EM efforts are associated with lower initial ratings and higher offering yields. We also find a statistically lower proportion of subsequent downgrades for firms with the most aggressive EM efforts, which is inconsistent with these firms’ inflated initial ratings. While some firms may attempt to mislead ratings agencies and market participants by window-dressing earnings, these efforts appear to be counterproductive.