Significant price changes are not only observed after changes of the rating, but also after changes of the rating outlook. In many cases technical factors represent a major reason for bond price changes after a negative rating action. In particular, large price movements can be observed when investment restrictions of institutional investors are triggered by a rating action.
A good example is the downgrade of Fiat in June 2002. The downgrade from Baa2 to Baa3 induced a large sell-off because investors anticipated
a further downgrade to high yield. But Figure 9.1 also shows that bond prices already fell significantly when Moody’s put Fiat on review for downgrade.
Empirical studies by Weinstein (1977), Hand et al. (1992) and Kliger and Sarig (2000) highlight the following relationships between rating changes
and a corporate issuer’s bond and stock prices:
- Bond prices adjust to a new rating.
- Equity prices also react on rating changes, usually opposite to the bond price movements.
- Surprise upgrades tend to result in a reduced implied equity volatility.
There is no indication that new rating information has an impact on firm value. According to the Asset Substitution Theory equity and bond prices react in opposite directions to rating changes, which ultimately leads to changes in the ratio of the market value of equity to debt.
Thought needs to be given to how one avoids head-on confrontation with the market leader, the brand with the most to lose. The market leader can be expected to react strongly against newcomers with the aim of crushing them before they have a chance to get established. The brand that is attacking the market leader therefore needs a valuable, attention-grabbing benefit or distinguishing feature, and the ability to convey its message convincingly. Once a position has been taken, the decisions that follow should ensure that it is consistently defended. Consistency is essential: positioning means striving for leadership in one particular area. Another important decision is therefore the choice of a powerful and simple message. For example, Volkswagen launched the Beetle in the United States with the slogan “Small is Beautiful” and for many years Mars bars purported to help you “Work, Rest and Play” (particularly if eaten every day). But you must know how the message will be received. Often the best way to establish a position is to associate with something that may already be in people’s minds. An example is customers’ desire for value, highlighted by low-cost airlines, such as easyJet, Ryanair and South-West Airlines, which emphasise their no-frills service and low prices.