Abnormal Return, Market Reaction around Rating Announcement in Tunisian Stock Market

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1 Internatonal Journal of Economcs and Fnance; Vol. 8, No. 7; 2016 ISSN X E-ISSN Publshed by Canadan Center of Scence and Educaton Abnormal Return, Market Reacton around Ratng Announcement n Tunsan Stock Market Wssem Daadaa 1 1 Laboratory of Economcs and Fnance Engneerng LIFE, Unversty of El Manar, FSEG Tuns, Tunsa Correspondence: Wssem Daadaa, Laboratory of Economcs and Fnance Engneerng LIFE, Unversty of El Manar, FSEG Tuns, Tunsa. E-mal: Wssem.daadaa@yahoo.fr Receved: July 21, 2015 Accepted: May 27, 2016 Onlne Publshed: June 25, 2016 do: /jef.v8n7p322 URL: Abstract Ths paper tests the market reacton and the stock prce change around ratng announcements n Tunsan stock exchange usng the event study methodology. We examne the mpact of the change ratng announcement on stock return frms from 2006 to The results show that only the negatve ratng wth downgrades note whch s assocated to negatve abnormal return. The market does not seem to be nterested upgrades ratng on the Tunsan market. The negatve reacton of the market can be explaned by leverage change, Book to Market rato and the level of the ratng fall. Keywords: ratng, abnormal return, event study 1. Introducton The number of ratng agences ncreases n ths decade; we estmate more than 100 ratng agences n the world. The role assumed by theses agences become more and more mportant and thers announcements consttutes an event that affect the market reacton and stock frm return. Analyzng the effect of ratng agences decson s an mportant event, essentally, to small markets. The ratng announcement has solcted a reach lterature n events studes lteratures. The ratng agences evaluate frms usng dfferent crtera and standard processes, and thus thers decsons can transmt a sgnal to the market. Lee-Hsen Pana et al. (2015) presents dfferent ndcators crtera used to evaluate frms: corporate transparency, frm performance and classfy frms n fve classes: the hghest corporate transparency s notfed to an A++ ratng, frm wth the lowest corporate transparency s C- ratng. The fve classes of ratng s: (1) complance wth the mandatory nformaton dsclosures, (2) tmelness of nformaton reportng, (3) dsclosure of fnancal forecast, (4) dsclosure of annual report, and (5) dsclosure of corporate webste. Before notfcaton announcements, ratng agences collect fnancal nformaton from publc and prvate sources. The change notfcaton announcement transmts new nformaton to the market; as a result, every degradaton, downgrades and changes should have a negatve effect on stock prces. Smlarly, put under postve survellance, upward revsons and postve changes should result mprovement value. Thus, the mpact of the company s notfcaton varaton on the share stock prce can be explaned by the effect of the new nformaton announced to the market, any change n the ratng s lkely to affect the fnancal captal cost, ther proftablty, and consequently ther market value. Smlarly, the company s notfcaton change can nfluence frm s growth and ther future vale. Researches n the subject of ratng have ncreasngly n vogue, but, the majorty of these studes were conducted n developed markets. Rare papers that have tested market reacton n emergng market. Ther reacton followng ratng announcements was always gnored, t must not also forget that the culture of usng ratng agences s not developed enough and so ths type of work allows, among others, to break the reluctance to seek ratng. The Tunsan captal market offers an nterestng area to test the ratng agences decson. We test the market reacton to ratng agency announcements by measurng stock abnormal return. The market characterstcs and the lack of pror studes motvate ths research and form the bass for ts contrbuton to the research lterature. Ths paper evaluates the nformaton value of Tunsan stock market after ratng agences announcements. The database of ths study ncludes ratng announcements for the perod 1 January 2000 to 31 December 2010, of Tunsan ratng agency. We use event study methodology to test stock abnormal returns around announcement date. 322

2 Internatonal Journal of Economcs and Fnance Vol. 8, No. 7; 2016 After a lterature revew of the man works that have approached the subject of ratng n Secton 2, we present our sample and methodology n Secton 3, Secton 4 wll be devoted to the presentaton of the results found, secton 5 explans the causes of the market reacton to the ratng announcement and we conclude n secton6. 2. Lterature Revew Reach lterature test the effects of ratng announcement to stock return and market reacton but results are mtgates. In developed market the majorty of theses papers conclude the exstence of an abnormal stock return markets to negatve ratng announcement (downgrades and negatve revew) but not to postve announcements (upgrades and postve revews ratng). Lterature n ths area s rch, Dchev and Potrosk (2001) has prmarly assessed the mpact of ratngs changes on the bond and stock markets, they fnds that ratng downgrades affect stock return and market reacton, but ratng upgrades do not carry the same nformatve value. Accordng to Ederngton and Goh (1998) most of the ratngs downgrades are preceded by declnes n frm ncome and analysts' forecasts. Goh and Ederngton (1993) demonstrate that the ratng announcement effect can be explaned by the frm purpose. Announcements ratngs drven by changes n the frm fnancal perspectve, such as the possble ncome growth or debt ncrease, can have an mpact on the stock market. Klger and Sarg (2000) fnd that the nformaton publshed by the ratng antcpated by the market, has no effect on the frm value, they add that the stock prce varaton depends by unexpected changes ratng. Elayan et al. (2003), analyzng the effect of ratng announcement n New-Zealand ratng, found abnormal stock return to postve announcements and suggested ths reacton depend wth corporate sze. However, Abad-Romero and Robles-Fernandez (2006) n Spansh market: consder the absence of reacton to downgrades and negatve announcement to upgrades. Koresh and Gall (2014) fnd that the market antcpates negatve decson pror to the announcement date. Wengne et al (2015) examne the mpact of ratng events for the perod The results show that both downgrades and mprovements ratngs have an mpact on the spread around announcement date. To explan the effect of ratng on stock prces, dfferent hypothess are presented: nformaton content hypothess, the sgnalng hypothess and wealth redstrbuton hypothess. Zama and McCarthy (1988) analyzes nformaton content hypothess, they consders that the ratng agences provde addtonal nformaton to the market about frm value. Ederngton et al. (1989) suggest that ratngs have greater nformaton content than the market stock prce snce t ncludes prvate nformaton collected by the ratng agences. Akhgbe et al. (1997) test sgnalng hypothess, they consder that a ratng change can be seen as a sgnal to the market about future profts, opportunty and cashes flows of frms. The hypothess of wealth redstrbuton as defned by Zama and McCarthy (1988), fnd the exstence of a conflct of nterest between bondholders and shareholders. Thus, lowerng the ratng reduces the bond prce, whch s exproprated from bondholders to shareholders and then ncreasng the share prce. Romero and Fernandez (2006) ndcate that ratngs downgrades have no effect n the stock prce but ratng upgrade announcement generates sgnfcant mpact on the Spansh market. They explan ths behavor by the wealth redstrbuton hypothess. Stener and Henke (2001) conclude that the factors explanng the market reacton s Downgrades nto speculatve class. Gropp and Rchards (2001) analyzes ratng change announcements on European banks. They attrbute the effect on stock prce to the Expected announcements hypothess. 3. Data and Emprcal Methodology 3.1 Data Our database ncludes 67 ratng announcements for the perod between 1997 to, 2012, collected from Tunsan Stock Exchange (TSE), classfed as 33 negatve ratng and 34 postve ratng. In Tunsa there s only one ratng company that evaluates Tunsan frms: Maghreb Ratng. We consder negatve ratng announcements n the cases of: downgrade note, negatve revew, downgrade and negatve revew; negatve outlook revson or current ratng confrmaton. Furthermore, ratng agences, n most cases, confrm the latter notaton. We consdered any confrmaton followng degradaton as a negatve ratng. We classfed the postve ratng announcements to the followng categores: upgrade; postve revew; upgrade and postve revew; postve outlook revson or current ratng confrmaton, endng a negatve revew. 3.2 Econometrc Model To test the mpact of announcements ratngs on the stock return, we follow Fama et al. (1969) procedures and termnology. We calculate daly abnormal returns and cumulatve abnormal returns on an event perod that begns twenty days before the announcement to twenty days after ths day. 323

3 Internatonal Journal of Economcs and Fnance Vol. 8, No. 7; 2016 In ths study, we analyze the mpact of ratngs change announcements on the underlyng ssuer s share prce. The estmaton wndow, runs from 60 tradng days before the announcement date, t=0, to 10 days before the announcement date. The event wndow runs from t =-10 to t=+10 (ten tradng date after announcement date). To test the effect of ratngs change announcements to the stock prce, we calculate daly abnormal returns and cumulatve abnormal returns durng the event wndow. To calculate abnormal returns, we use the market model and we calculate normal returns n the perod before event ( sxty days before announcement to ten days before ths day). We use the market model to calculate the estmator: follow:, et for each share, ths model was estmated as t R t R (1) mt t E( t ) = 0 and Var ( t ) =σ2 R and R m are the day returns of equty and the market ndex. We calculate the abnormal return on day t for share (RA t ) as follow: RA R ˆ ˆ R ; =1 N (2) RA t : abnormal return on day t for share. t=0 s the announcement day. t t mt E ( RAˆ t ) = RA t = t t mt 2 2 and V ( ˆ ) RA t R (3) To test the sgnfcance of the average resduals we uses student test Tpar, the cross (Note 1) test, and sgne test T sgne. We calculate the cumulatve abnormal return CAR n the wndows of t=-60 to t = Emprcal Result The abnormal returns around ratng announcement are presented n Tables 1 to 4. In Tables 1 and 2, the sample s classfed n fnancals and non fnancals companes for negatve (n Table 1) and postve ratng (Table 2). We fnd that the stock prce reacton to postve and negatve ratng announcement s more mportant and sgnfcant for fnancals companes. The market seems to be more nterested n the ratng announcement of Tunsans banks. Table 3 present the abnormal return of stocks around announcement day of negatve ratng, the result s negatve and statstcally sgnfcant (-0.48%) n the announcement day (t=0). We fnd sgnfcant abnormal return responses followng downgrades ratng announcements. We consder that downgrades generate stronger and more predctable results than upgrades. We conclude then, the negatve and sgnfcant stock prce reacton to negatve ratng announcement. The negatve reacton perssts and these downward trends contnue sx days after announcement day (graph n 1). Ratng downgrades announcement generate stronger and more predctable results than upgrades, whch s n lne wth the majorty of the fnancal lterature dealng wth ratng changes. Generally, the ratng agency publshes the future prospects for long-term, and pror changng notfcaton, decdes to put frm under survellance. Ths procedure helps nvestors to antcpate the ratng degradaton and react even before the publc announcement, ths explan the week market reacton to the negatve ratng announcement compared to other fnancal market. The decson to revse the ratng down s seen as a bad sgnal by nvestors. They are aware about the future frm performance and react, then, before the event date. Generally, when the nformaton s made publc, all nvestors are nformed and the event loses ts nformaton relevance. Accordng to the table (3), the postve ratng announcement does not nfluence the abnormal returns. Ths result corroborates those of Barron et al. (1997), L et al. (2004) but contradcted those of Elayan et al. (2003) and Creghton et al (2006) who found a sgnfcant response after postve negatve ratngs announcements. In Tunsan market, the postve ratng announcement s not consdered by nvestors as favourable nformaton. Consequently, the upgradng ratng may reflect a prudent corporate behavour. The negatve reacton to downgrades ratng leads us to search the factors that have caused ths abnormal return. Varous varables are presented to explan ths reacton. 324

4 Internatonal Journal of Economcs and Fnance Vol. 8, No. 7; 2016 Table 1. Cumulatve abnormal return to downgrade ratng announcement Sample 1: Fnancal Companes Sample 2: Non Fnancals Companes Event perod (0;20) (-20;20) (-1;1) (-5;5) (0;20) (-20;20) (-1;1) (-5;5) Mean E Medam STD t-test p-value test wlcoxon p-value Table 2. Cumulatve abnormal return to upgrade ratng announcement Abnormal return: Fnancals companes Abnormal return: Non Fnancals companes Event perod (0;20) (-20;20) (-1;1) (-5;5) (0;20) (-20;20) (-1;1) (-5;5) Mean Medam E E-05 STD t-test p-value test wlcoxon p-value Table 3. Abnormal return around negatve ratng RAM RAC T1 student test T2 rang test T3 sgn test -5 0,000-0,001 0,235 0,870 0, ,001 0,000 0,612 0,174-0, ,002 0,003 0,960 1,914 0, ,001 0,001-0,651 0,174-1, ,002 0,003 0,764 0,870-0, ,004* -0,001-1, , ,000-0,002-0,287 0,174-0, ,003-0,005-1,049 0,522-0, ,001-0,006-0,490 0,870-1, ,000-0,006-0,061-0,522-1, ,001-0,005 0,625 1,218 0,590 RAM: Average abnorma return, RAC: cumulatve abnormal return, T1: student test; T2: rang test; T3: sgn test. * sgnfcatvty to 10%; ** sgnfcatvty to 5%. Table 4. Abnormal return around postve ratng RAM RAC T1 student test T2 rang test T3sgn test -5-0,027-0,153-1,556 0,000-1, ,032-0,185-1,823 0,000-1, ,038-0,223-2,161-0,342-0, ,045-0,269-2,584-0,685-1, ,045-0,315-2,564 0,000-1, ,042-0,358-2,414 1,371 1, ,037-0,395-2,098 1,028 0, ,036-0,432-2,071 1,371 0, ,037-0,470-2,135-1,028-1, ,039-0,509-2,228 1,028 0, ,037-0,547-2,114 1,028 0,046 RAM: Average abnorma return, RAC: cumulatve abnormal return, T1: student test; T2: rang test; T3: sgn test. 325

5 Internatonal Journal of Economcs and Fnance Vol. 8, No. 7; Fgure 1. Stock prce reacton to downgrade ratng announcement Fgure 1 shows slghtly postve pre downgrade abnormal return, ths reacton s followed by sharp negatve reacton wth sharp negatve CARs followng the ratng downgrades announcements. Then, the pattern reverses agan and we the abnormal return ncrease 7 days after announcement. The results from upgrade announcements were not statstcally sgnfcant. 5. Factors Explaned Market Reacton Fnancal lterature analyzng ratng effect on stock market concludes that the sze (total assets or total sales) of an ssuer s an mportant factor explanng the market reacton. Others authors use total assets, leverage, proftablty Return on assets ROA as ndependent varables. Snce ratng process between fnancal and non-fnancal frms s dfferent, we utlze a dummy varable to dstngush them. FN s 1 f the ratng changes apply to fnancals frms. The effect on stock prce at announcement day can also explaned by frequency of downgrades, upgrades or f the frm s putted on survellance. Make to negatve survellance transmt a sgnal to the market that the frm s n dffculty and prepare the downgrade. The market can then expect the future ratng announcement. Hence we defne MS as dummy varable equal to one f company s make to survellance n the precedng ratng and 0 f not. We also test the hypothess that equty markets wll react more strongly to ratng change announcements for frms wth speculatve grade ratngs than to those wth nvestment grade ratngs. We consder DR dummy varable equal to 1 f the ratng change s from speculatve grade note (BB+/BB1 or lower) and 0 otherwse. Book to market raton BTM measure the market performance at the announcement date of ratng. Independents varables Expected Sgns Sze (Log VM) (+) Leverage (ED) (-) BTM (-) Dowongrade (DR) (-) Make on survellance (MS) (-) Fnancals companes (FN) (-) To explan the market reacton to the negatve announcement we use model follow: CAR 0 1 VM ) 2ED 3BTM 4FN 5DR 6 log( MS (4) In ths model DR, FN et MS are bnary s varables: FN=1; f fnancal frm and 0 f not DR =1 f the ratng note s low then (3B) and 0 f not, MS=1 f the announcement proceeded by make on negatve survellance. VM: Frm sze measured by log of the market value of equty; ED: frm leverage: the debt rato, measured by total debt to book value of assets; BTM: s the book to market rato. 326

6 Internatonal Journal of Economcs and Fnance Vol. 8, No. 7; 2016 Table 5. Factors explaned market reacton Varables Coeffcent Std. Error t-statstc Prob. C VM ED * BTM ** DR -8.85E-12* 5.12E MS FN R-squared Adjusted R-squared FN=1; f fnancal frm and 0 f not; DR =1 f the notfcaton s low then (3B) and 0 f not, MS=1 f the announcement s related to make on negatve survellance.vm: frm sze measured by log of the market value, ED: frm leverage: the debt rato, measured by total debt to book value of assets. (BTM) s the book to market rato. From the Table 5, we can conclude that the negatve abnormal return around announcement can be explaned by frm leverage, proftablty and the level of downgrades. For ratng downgrades, we confrm that ratng downgrades for speculatve grade frms have more severe prce reactons than those for nvestment grade frms. The results show that the debt rato s a sgnfcant varable and that the relatonshp between debt rato and the abnormal return s postve. Ths result confrms L et al. (2004) and L et al. (2006), who concluded that the debt rato s correlated to the ratng downgrade, expressng the deteroraton of the company's fnancal structure. Our result demonstrates that frm sze s not sgnfcant and does not explan the market reacton to the announcement. Ths corroborates the results of L et al. (2004) that fnd no effect of sze on the abnormal return. Note also that the rato Book to Market has a sgnfcant effect and can explan the market reacton at the announcement date. We conclude also the negatve mpact of BTM on the abnormal return followng announcements dates. Investors beleve that the company's value s less than the book assets after negatves ratngs announcements. The level ratng downgrade has a strong sgnfcance explanng the abnormal return, ths varables s correlated to the level of lowest ratng (below BBB). Ths results confrms those of Holthausen and Leftwch (1986), Joron and Zhang (2005) who consders that the downgrade from one class to another are assocated wth sgnfcant negatve abnormal return. Smlarly, Creghton et al. (2006) show that n the case of the downgrade, ad effects are greater. 6. Concluson In ths paper we tested the mpact of ratng changes on stock return n of Tunsan stock market. We appled the event study methodology and used two nonparametrc tests and student test: test and sgn rank test. Our results demonstrate that the market only react to degradatons announcement of ratng. When the announcement s related to mprovement notfcaton, there s not an abnormal return around ths date. We can conclude that the market was antcpated the event before hs announcement, ths nformaton was used pror to ts publc dvulgaton. To explan ths market reacton to negatve ratng announcement, abnormal return s tested by dfferent varables related to characterstcs of frm, the operaton and fnancal market. We have dentfed sgnfcant effects for the debt rato, the rato Book to Market and level of downgrade. These results corroborate studes L et al. (2004), Holthausen and Leftwch (1986), Joron and Zhang (2005) and Creghton et al. (2006). It appears that the announcement of such nformaton on the stuaton of the company led to a negatve mpact on stock prces. Ths reacton occurs on the day of the announcement and contnued several days later. References Abad, R., & Robles, F. (2006). Rsk and Return Around Bond Ratng Changes: New Evdence From the Spansh Stock Market. Journal of Busness Fnance & Accountng, 33(5-6), Akhgbe, A., Madura, J., & Whyte, A. M. (1997). Intra-ndustry effects of bond ratng adjustments. The Journal 327

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8 Internatonal Journal of Economcs and Fnance Vol. 8, No. 7; 2016 Stener, M., & Henke, V. G. (2001). Event study concernng nternatonal bond prce effects of credt ratng actons. Internatonal Journal of Fnance and Economcs, 6, Zama, J. K., & McCarthy, J. (1988). The mpact of bond ratng changes on common stocks and bonds: Tests of the wealth redstrbuton hypothess. The Fnancal Revew, 23(4). Note Note 1. T cross = RAM/SRAM SRAM t 1 N 1 N 1 ( RA, t RAM t ) 2 Copyrghts Copyrght for ths artcle s retaned by the author(s), wth frst publcaton rghts granted to the journal. Ths s an open-access artcle dstrbuted under the terms and condtons of the Creatve Commons Attrbuton lcense ( 329