Sovereign Ratings and Firm Investments : A Cross-country Evidence

This paper explores the impacts of sovereign rating changes on domestic firm investments. Utilising a large sample of 1,589 rated firms in 40 countries during the period of 1995 to 2021, we document significant impacts of sovereign rating events on firm investments, proxied by total, short- and long-term investment. The results remain robust when we control for the corporate creditworthiness. Specially, firms domiciled in a recently downgraded sovereign reduce their total investments, and shift their investment from long- to short-term investment, given their unaffected credit ratings after undesirable sovereign rating events. Conversely, firms’ investment is unaltered by the sovereign upgrades. Our findings also confirm that the impacts of sovereign rating changes are contingent on the firm's financial constraints, as it is more visible in firms with financial constraints proxied by firm size, age, and KZ index. Further, the corporate-sovereign rating spillover is considerably affected by the government debt overhang as it negatively moderates the impacts of sovereign downgrades on corporate investment. Our findings remain reliable under a battery of robustness tests, which can propose several practical implications for both businesses and governments