A rating trigger is a particular type of debt covenant that mandates the borrower to maintain its own credit rating above a certain rating threshold, requiring in the event of a rating downgrade the adoption of specific enforceable actions aimed at securing the lender claims from the borrower's higher risk level. Rating triggers lower the cost of borrowing capital, but in case they are activated they exacerbate the borrower's need for liquidity just in the moment when its credit risk is higher, making the borrower's default more likely to occur. Despite the potential threat posed by rating triggers on debt markets, these contractual devices remain almost unregulated both in the U.S. and in Europe. The purpose of this paper is first to analyze the effects rating triggers can have on overall market risk and second to assess the proliferation of rating triggers among large U.S. companies in order to ensure whether these contractual devices need a stricter regulation. The article is divided in two parts. From section 2 to 5, I provide an overview on the different types of triggers and analyze the rationale behind their use in terms of advantages and disadvantages for both issuers and investors. From section 6 to 9 I perform an empirical analysis by assessing the rating triggers that have been used by Dow Jones Industrial Average index companies. I then examine the correlation between the use of rating triggers and the companies’ risk profiles by measuring their credit ratings and their Altman’s Z-Scores in order to find out whether triggers are mostly used by risky companies, capable of being impaired by the triggers’ activation and thus posing a threat to market stability. Then in section 10 I draw the conclusions suggesting the introduction by U.S. and European regulators of a specific duty to disclose all the rating triggers that listed companies include every year in bond indentures and in financial contracts.

Parmeggiani, F.. "Rating Triggers, Market Risk and the Need for More Regulation" Working paper, CEFIN WORKING PAPERS, Dipartimento di Economia Marco Biagi - Università di Modena e Reggio Emilia, 2012. https://doi.org/10.25431/11380_1197565

Rating Triggers, Market Risk and the Need for More Regulation

Parmeggiani, F.
2012

Abstract

A rating trigger is a particular type of debt covenant that mandates the borrower to maintain its own credit rating above a certain rating threshold, requiring in the event of a rating downgrade the adoption of specific enforceable actions aimed at securing the lender claims from the borrower's higher risk level. Rating triggers lower the cost of borrowing capital, but in case they are activated they exacerbate the borrower's need for liquidity just in the moment when its credit risk is higher, making the borrower's default more likely to occur. Despite the potential threat posed by rating triggers on debt markets, these contractual devices remain almost unregulated both in the U.S. and in Europe. The purpose of this paper is first to analyze the effects rating triggers can have on overall market risk and second to assess the proliferation of rating triggers among large U.S. companies in order to ensure whether these contractual devices need a stricter regulation. The article is divided in two parts. From section 2 to 5, I provide an overview on the different types of triggers and analyze the rationale behind their use in terms of advantages and disadvantages for both issuers and investors. From section 6 to 9 I perform an empirical analysis by assessing the rating triggers that have been used by Dow Jones Industrial Average index companies. I then examine the correlation between the use of rating triggers and the companies’ risk profiles by measuring their credit ratings and their Altman’s Z-Scores in order to find out whether triggers are mostly used by risky companies, capable of being impaired by the triggers’ activation and thus posing a threat to market stability. Then in section 10 I draw the conclusions suggesting the introduction by U.S. and European regulators of a specific duty to disclose all the rating triggers that listed companies include every year in bond indentures and in financial contracts.
2012
Dicembre
Parmeggiani, F.
Parmeggiani, F.. "Rating Triggers, Market Risk and the Need for More Regulation" Working paper, CEFIN WORKING PAPERS, Dipartimento di Economia Marco Biagi - Università di Modena e Reggio Emilia, 2012. https://doi.org/10.25431/11380_1197565
File in questo prodotto:
File Dimensione Formato  
CEFIN-WP35.pdf

Open access

Tipologia: Versione pubblicata dall'editore
Dimensione 335.62 kB
Formato Adobe PDF
335.62 kB Adobe PDF Visualizza/Apri
Pubblicazioni consigliate

Licenza Creative Commons
I metadati presenti in IRIS UNIMORE sono rilasciati con licenza Creative Commons CC0 1.0 Universal, mentre i file delle pubblicazioni sono rilasciati con licenza Attribuzione 4.0 Internazionale (CC BY 4.0), salvo diversa indicazione.
In caso di violazione di copyright, contattare Supporto Iris

Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/11380/1197565
Citazioni
  • ???jsp.display-item.citation.pmc??? ND
  • Scopus ND
  • ???jsp.display-item.citation.isi??? ND
social impact