Cash Flow Story
CASH FLOW STORY
The paper provides insights into the effect of various cash flow accounts on the credit ratings. Using the study we can figure out that dividends and interest expense have significant explanatory powers. This in effect tells us that the capital structure of the firm will have significant explanatory powers. Even though there are 15 cash inflow/outflow accounts, a few of the accounts account for a large proportion of the cash flows and hence have a strong bearing on the credit ratings. The exhibits that I find the most useful are Exhibit 4,5,6,8 and 10. The NOF/TCI ratio is expectedly better for higher rated companies than for lower rated companies. This might be because if a firm is in good health, it has a good cash generating ability, with which it pays off its interest expense and which effectively improves its credit rating and the opposite is true for bottom rated firms.
Although its not directly implied in the paper but can be inferred from the data in Exhibit 3, is the fact that once the firms get a lower rating from the credit ratings, the market views these firms unfavourably and hence these firms pay a higher interest expense and thus will have a higher cash outflow. Now, this higher cash outflow in the form of interest expense is related to a lower rating and thus forms a cycle. This makes it hard for the firms to claw back into top credit rated category. The numbers in Exhibit 3 highlight this fact. The results from the regression (Table 1 below) shows that the co-eff of number of BBB and B rated firms are negative and significant. This must in effect conclusively prove that interest expense can be a significant force in deciding the credit rating of a firm.
Exhibit 4 and 5 show that as the interest expense reduces and dividends increases, it results in the firms getting a lower credit rating. This must tell us that the co-efficient resulting from the regression using these factors