The Change in Rating Standards on R&D Expenditures

[Purpose] We examine whether the rating agencies have changed their standards on R&D expenditures over time. Further, to understand the reason why the rating agencies have changed their view on R&D, we examine whether there is a change in the uncertainty generated by R&D expenditures. [Methodology] Using U.S. firms with a credit rating from 1988 to 2016, we investigate the temporal change in the association between credit ratings and R&D expenditures. [Findings] We find that the negative relation between credit ratings and R&D in early periods has become weaker over time. In addition, we find that the positive relation between R&D expenditures and future earnings volatility for sample firms has become weaker over time, suggesting one of a possibility for the observed attenuation in the negative outlook on R&D among rating agencies. [Implications] Our study proposes and empirically substantiates the important role of innovative knowledge, which is created by corporate R&D activities, in determining firms’ credit rating. Also, our findings contribute to the literature on credit rating by providing evidence on the determinant-level change in corporate rating standards.