Do Firms Target Credit Ratings or Leverage Levels Darren J' Kisgen Discussion by: Michael R' Roberts

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Do Firms Target Credit Ratings or Leverage
Levels?Darren J. KisgenDiscussion
byMichael R. Roberts2006 Western Finance
Association
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Summary

• The question
• Do credit ratings changes affect financial
  policy?
• Empirical Approach
• Regress net security issuances (net debt net
  equity) on an indicator for a ratings change and
  controls
• Results
• Downgrades ? relatively less net debt issuance
• Upgrades ? no significant affect
• Conclusion
• Firms target minimum credit rating levels

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Overview

• What I like about the paper
• This is an interesting topic with relatively
  little hard evidence (Faulkender and Petersen
  (2005), Kisgen (2005), Lemmon and Roberts (2006))
• The paper is well-written (but documentation
  could be improved)
• Remainder of the discussion
• Wheres the identification coming from?
• Is this the right empirical specification?
• What do the results mean?

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Where is the Identification Coming From?

• The empirical model is
• This specification assumes that, conditional on
  firm characteristics, firms are randomly assigned
  upgrades and downgrades in their credit
  rating?!?!?!
• This endogeneity must be addressed.
• Faulkender and Petersen (2005) use IV
• Lemmon and Roberts (2006) use a natural experiment

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Do We Have the Right Empirical Specification?

• What is the economic model (i.e., null
  hypothesis) motivating the empirical
  specification?

• This implies the following firm FE model

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Do We have the Right Empirical Specification?

• Alternatively,

• This implies the following differences model

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Do We have the Right Empirical Specification?

• Darrens specification

implies

• None of this addresses the endogeneity issue

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What do the Results Mean?

• Credit ratings matter because they are proxying
  for some underlying friction (e.g., information
  asymmetry, bankruptcy costs, capital
  constraints)
• Theres no effort to distinguish among these
  alternative hypotheses.
• Firms target a credit rating?
• How can your empirical framework distinguish
  targeting a credit rating a range of leverage?
  Observationally equivalent without exogenous
  variation?
• 70 of public firms dont have a credit rating
• No effect of downgrades on leverage (0.6)

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Concluding Thoughts

• This is an interesting and relevant issue.
  However, I think addressing it is more difficult
  than what this paper suggests
• My recommendations are to
• Find a source of exogenous variation or, write
  down a model that provides identifying
  restrictions
• Carefully state what the empirical specification
  is and why
• Distinguish between (some) of the explanations
• Carefully document what you do
• Addressing these issues will result in a very
  nice paper