Voluntary Disclosure during Credit Watches: Do Credit Rating Agencies Concern about Disclosure Quality?

This paper investigates managers' voluntary disclosure during credit watch periods. A credit watch warns investors of a possible rating revision and the uncertainty in a firm's future creditworthiness and, therefore, is accompanied by intense demand for information. We investigate 1) whether managers disclose more information during credit watches; 2) whether managers strategically disclose biased information in response to credit watches, and 3) whether and how effectively credit rating agencies monitor managers' voluntary disclosure in such a setting. Using credit watch data from Moody's, we report that 1) management earnings forecast frequency is higher during credit watches, 2) compared with non-watch periods, management earnings forecasts disclosed during credit watches are more optimistically biased and less accurate in case of downward watches, but less optimistically biased and more accurate in the case of upward watches, and 3) optimistically biased and less accurate forecasts issued during credit watches are not associated with resolutions of downgrade watches, but are associated with less favorable resolutions of upgrade watches. Our findings suggest that managers' voluntary disclosure increases during credit watches, but the credibility of forecasts depends on the direction of credit watch. Rating agencies play an important but limited role in monitoring the credibility of voluntary disclosures.