Credit Rating and Its Interaction With Financial Ratios: A Study of BSE 500 Companies

Credit Rating and Its Interaction With Financial Ratios: A Study of BSE 500 Companies

Shraddha Mishra (IILM University, India) and Reenu Bansal (IILM University, India)
Copyright: © 2019 |Pages: 18
DOI: 10.4018/978-1-5225-7399-9.ch014

Abstract

Credit rating evaluates credit worthiness of corporate and securities issued by government. It provides investors with unbiased reviews and opinion about the credit risk of various securities. The main aim of the chapter is to identify the relationship between the financial ratios and rating symbols. The sample of 158 firms is taken into consideration that discriminates best ratings given by credit rating firms. In order to examine the variability in ratings issued by various rating agencies, the time period of eight years starting from April 2009 to March 2017 has been selected. The study employed the multinomial logistic regression model to explain the relationship among the variables. The analysis suggests that variables such as debt to equity ratio, profit after tax, returns on capital employed, and return on net worth are those having the highest impact on ratings and thus there is also discriminating power among Indian rating agencies.
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Introduction

  • Purpose: Credit rating agencies have bought revolutionary changes in Indian capital market by introducing various innovations. Credit rating evaluates credit worthiness of corporate and securities issued by government. It provides investors with unbiased reviews and opinion about the credit risk of various securities. The main aim of the study is to identify the relationship between the financial ratios and rating symbols.

  • Design: Out of various rating agencies in India only four are taken into consideration for the purpose of analysis i.e. CRISIL, ICRA, CARE and FITCH. The short-term liquidity ratio considered in the study is Current Ratio; long-term solvency ratio includes gearing ratio, Total Indebtedness Ratio and Interest Coverage Ratio. The profitability ratio includes Profit before interest and tax; Net cash accruals to total debt; profit after tax (PAT) margin; Return on capital employed and Return on Net worth.

  • Methodology: The sample of one hundred and fifty eight firms is taken into consideration that discriminates best ratings given by credit rating firms. The selections of these companies were as per the market capitalization from the list of BSE 500 as on 31st March, 2017. In order to examine the variability in ratings issued by various rating agencies; the time period of eight years starting from April, 2009 to March, 2017 has been selected. The study employed the multinomial logistic regression model to explain the relationship among the variables.

  • Findings: Arora (2003) had used anova model to predict the inconsistency. The anova result signifies that the methodologies of all four credit rating companies are inconsistent in nature. The analysis suggests that variables such as debt to equity ratio, profit after tax; returns on capital employed and return on Net worth are those having the highest impact on ratings and thus there is also discriminating power among Indian rating agencies. The results are consistent with the following studies; Pinches and Mingo (1973), Ang and Patel (1978), Wingler and Watts (1980), Belkaoui (1980) and Altman and Katz (1976), and Novotná (2012).

  • Practical Implications: This article will help the investor to evaluate the efficiency of credit rating assigned by all the four credit rating agencies in India. Taking into consideration, the fundamental analysis of stock valuation, analyst would be able to define the competent agency among all. The study will also help the credit rating firms to know their performance in long term.

The economic scene in the post-independence period has seen a sea change, the result being that the economy has made enormous progress in diverse fields. Indian economy has expanded quantitatively and diversifies its economic activities. The experiences of 1980s have led to the conclusion that needs efficient financial systems to rely on market based decision making.

The financial system is the most important institutional and functional vehicle for economic transformation. The financial system is a set of inter-related activities which aims at establishing and providing a regular, smooth, efficient and effective linkage between depositors and investors. Indian financial system comprises of financial institutions, financial services, financial markets and financial instruments which influence the generation of savings, investments, capital formation and growth.

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