Bond ratings, bond yields and financial information*

Abstract. The role of accounting information in investment decision making and capital markets has been investigated by exploring fundamental connections between accounting numbers and market†based phenomena of interest. Studies of bond rating predictions have described how bond raters make their judgments as a function of accounting and other data. This study expands our knowledge of these fundamental connections by investigating whether bond ratings have a direct impact on bond yields and how accounting information impacts the bond yields—directly, or indirectly through the bond ratings. A simultaneous equation system is constructed using firm†specific financial information, bond ratings by two major rating agencies, and initial offering yields. The sample used in this study consists of 189 new issue industrial bonds rated by both Standard & Poor's and Moody's that were issued from 1981 through 1985. Tests of alternative structural model configurations provide evidence regarding the interrelations between bond ratings, financial information, and bond yields. The improvements in the statistical methodology lead to a better understanding and assessment of the relative roles of bond ratings and financial information in setting bond prices. The use of simultaneous equation modeling allows the interrelations among yields, ratings, and financial information to be assessed and allows the direct and indirect effect of financial information on yields to be estimated. This results in the ability to conclude that financial information affects bond ratings, that bond ratings directly affect bond yields, that financial information also directly affects bond yields, and that financial information indirectly affects bond yields through its effect on ratings. The role of accounting information in setting bond market prices is clarified using this approach. RA©sumA©. On a A©tudiA© le rA´le de l'information comptable dans la prise de dA©cisions d'investissement et sur les marchA©s financiers en explorant les liens fondamentaux entre les donnA©es comptables et les phA©nomA¨nes d'intA©rAat fondA©s sur le marchA©. Les A©tudes portant sur les prA©dictions relatives A la notation des obligations ont dA©crit de quelle faA§on les services d'information financiA¨re jugeaient de la valeur des obligations A partir de donnA©es, comptables et autres. Les auteurs de la prA©sente A©tude A©largissent la connaissance de ces liens fondamentaux en analysant la possibilitA© que la notation des obligations ait une incidence directe sur leur rendement et la faA§on dont l'information comptable agit sur le rendement des obligations, que ce soit directement, ou indirectement par l'intermA©diaire de leur notation. Les auteurs constuisent un systA¨me d'A©quations simultanA©es A l'aide de l'information financiA¨re propre A l'entreprise, des cotes accordA©es aux obligations par deux services majeurs d'informations financiA¨res et du rendement des A©missions initiales. l'A©chantillon qui a servi A l'A©tude compte 189 nouvelles A©missions d'obligations dans le secteur industriel, cotA©es A la fois par Standard & Poor's et Moody's, qui ont A©tA© A©mises entre 1981 et 1985. Les tests appliquA©s aux configurations de rechange du modA¨le structurel A©tablissent clairement les relations entre la notation des obligations, l'information financiA¨re et le rendement des obligations. Les progrA¨s de la mA©thodologie statistique ont menA© A une meilleure comprA©hension et une meilleure A©valuation des rA´les relatifs de la notation des obligations et de l'information financiA¨re dans l'A©tablissement du prix des obligations. La modA©lisation d'A©quations simultanA©es permet, d'une part, l'A©valuation des relations entre rendement, notation et information financiA¨re et, d'autre part, l'estimation des consA©quences directes et indirectes de l'information financiA¨re sur le rendement qui doit Aatre estimA©, ce qui amA¨ne A conclure que l'information financiA¨re a une incidence sur la notation des obligations, que la notation des obligations exerce une influence directe sur le rendement des obligations, que l'information financiA¨re touche A©galement de maniA¨re directe le rendement des obligations et qu'elle a une incidence indirecte sur le rendement des obligations, par le truchement de son incidence sur la notation. Le rA´le de l'information comptable dans l'A©tablissement de la valeur marchande des obligations est A©clairci grA¢ce A cette mA©thode.

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