The impact of company credit rating change on equity prices on the Johannesburg Stock Exchange

Abstract

The role of credit rating agencies on capital markets and their perceived effectiveness or ineffectiveness thereof continues to be a debated topic in various quarters of the society. In South Africa this debate is often elevated when there are impending sovereign rating downgrades. Against this backdrop, this study sought to establish whether credit rating change announcements impact stock prices of firms listed on the Johannesburg Stock Exchange. South Africa as a sovereign country has been enduring adverse credit ratings, whilst on the contrary the domestic stock market has been rising and in the first half of the 2015 fiscal year, the stock market reached unprecedented levels, despite the country’s credit downgrades and negative economic outlook. This study investigated the impact of credit rating change on equity prices of firms listed on the Johannesburg Stock Exchange using the event study methodology. Examining the rating data from Fitch; Moody’s; Standard & Poors; and Global Credit Ratings and using the market model to compute the abnormal stock returns over a 10-day event window period, the Johannesburg Stock Exchange All Share Index returns was used as a performance benchmark and accordingly the significance test was applied. The study found insignificant evidence on the impact of credit rating upgrades on equity prices which suggest that rating upgrades are largely anticipated by the market. On the contrary, the study found significant evidence that rating downgrades, result in significant negative abnormal returns from three days prior to the rating downgrade announcement. The findings of this study therefore reaffirms the information hypotheses of the credit rating announcements that suggest that, credit rating change announcements disseminated by the credit rating agencies contains pricing relevant information. This pricing relevant information is more pronounced for rating downgrades than when it is upgrades.