Abstract

We examine the impact of mergers and acquisitions on a firm's bond ratings using a large sample of U.S. firms between 1990 and 2012 that experienced a rating change. For both the upgrade and downgrade samples, we investigate the acquisitions undertaken by these firms within three years and five years before the rating change. We find that firms with positive announcement period abnormal returns around the acquisition preceding the rating change are more likely to experience a rating upgrade, whereas firms with a rating downgrade had abnormal returns around acquisitions that were more negative. Before the bond rating change, the upgraded firms make better acquisitions compared to downgraded firms; however downgraded firms make fewer but higher quality acquisitions in the post rating change period. We further employ the Berkovitch and Narayanan (1993) methodology to distinguish between the synergy, agency and hubris motives for acquisitions. We determine that for rating upgrades, the acquisitions are mostly motivated by synergy in the years prior to the upgrade announcement. For rating downgrades, there is some evidence to suggest that the acquisition motive is either agency or hubris prior to the downgrade announcement. However, in the post rating period, our evidence suggests that value creation through synergy is an important motive for acquisitions in subsequent years for both, upgraded and downgraded firms.