Effects of credit rating changes on corporate capital structure in South Africa

Abstract

Orientation: The changes in credit ratings for corporates have a great impact on corporate funding decisions, costs and capital structures.

Research purpose: The study aimed to identify the relationship between credit ratings and capital structures in emerging economies such as South Africa.

Motivation for study: Investors, financial managers, regulatory authorities and financial analysts focus on the credit quality of companies as measured by credit ratings in making financing and investing choices. The credit rating is a significant communication tool, and businesses consider it crucial when deciding on capital structure. An ideal capital structure of a company is one that reduces its relative cost of capital by striking a balance between the capital structure proportions to enhance value.

Research approach, design and method: A systematic and quantitative approach using semi-annual data from 2011 to 2020 sourced from EquityRT and the JSE.

Main findings: Credit ratings have a positive and material impact on the capital structure decisions of South Africa’s top 40 companies. Thus, a higher debt-to-asset ratio is encouraged when the credit score improves, and a downgrade is more likely to be followed by a capital reduction behaviour.

Practical/managerial implications: Investors, managers and regulators can use the findings of this study for financial decision-making purposes, anticipating changes in future corporate capital structures and monitoring funding opportunities as well as balancing debt to equity in the capital construction of an organisation.

Contribution/value-add: The evidence generated by the study presented that credit rating changes influence capital structure.