A Study on the Association between Credit Ratings and Capital Structure Decision in Korea

The objective of this paper is to examine to what extent credit ratings directly affect capital structure decisions and to analyze the effect of credit ratings of firms and how managers use information about credit rating in determining or changing the capital structure of firms in Korea. I examine discrete costs and benefits associated with firm credit rating level differences and empirically test whether managers' concerns for these costs and benefits directly affect debt and equity financing decisions. According to my empirical result, firms near a credit rating upgrade issue less debt relative to equity than firms not near a change in a credit rating. This capital structure decision making behavior by managers is generally consistent with discrete costs and benefits of rating changes but has not been fully explained by traditional capital structure theories. Overall, the results of this paper is associated with previous empirical tests of the pecking order and tradeoff capital structure theories. In conclusion, this paper will contribute to the theoretical and empirical capital structure decision frameworks by examining the influence of credit ratings on capital structure decisions in Korea.