Do financial statement adjustments matter in credit analysis? Evidence from the global telecommunications industry

This thesis investigates whether financial statement adjustments made during the rating process matter in credit analysis. Firstly, the thesis investigates whether reporting standards and company-specific factors are associated with financial statement adjustments. Secondly, the thesis examines whether financial statement adjustments are associated with actual credit ratings. The data used in the analyses is provided by one of the largest credit rating agencies, referred to as Credit Rating Agency X. The main data consists of the time period 2004-2007, including 196 companies reporting under US GAAP, IFRS and local GAAPs. Moreover, the IFRS companies included in the main data are analyzed more thoroughly in terms of the adjustment type, using the second set of data from year 2007. The data only includes companies active in the telecommunications industry. The first part of the empirical analyses aims at explaining financial statement adjustments using a linear regression method. The second part, on the other hand, includes credit rating models estimated also with a linear regression method. The adjustment variables are added one at a time in the rating models in order to investigate the association between financial statement adjustments and ratings. In an additional test, the explanatory powers resulting from reported and adjusted data are compared. First, the evidence suggests that capital intensity, operative risk and leverage are important in explaining financial statement adjustments. Additionally, public companies face fewer adjustments relative to private companies. The ultimate underlying reason for financial statement adjustments seems to be company-specific decisions concerning financing and capital structure as well as contractual matters. Second, the evidence demonstrates that, without any adjustments, credit ratings are higher for companies reporting under IFRS relative to companies reporting under US GAAP. However, adjustments increase ratings for US c