2. How Credit Ratings Affect the Capital Structure of a Firm

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2. How credit ratings affect the capital structure of a firm
Credit ratings is the assessment of the credit worthiness of a firm based on historyof borrowing and repayment. Credit rating is the credit worthiness of a debtor. The debtors ability to pay back the debt.
Companies with high rating (AAA) have a good market reputation and logically would avoid not being in favor of more debt in capital structure to save them from any adverse circumstances. High credit ratings expose a firm to obtain higher external sources of finance
Medium rated firms have access to cheaper debt financing than the highly rated firms.
A firm can establish a reputation over time as a sound borrower by repaying debt in a timely manner. That reputation is conveyed by rating agencies, which use both public and private information to form opinions about borrowers’ payment history and their expected ability to repay debt .
An increase (decrease) in a firm’s credit rating affects that firm’s ability to borrow by lowering (raising) its cost of debt. If a firm’s cost of debt is too high, that firm might pass up positive net-present-value opportunities. Since the value of a firm equals the sum of assets in place and the present value of growth opportunities a firm’s ability to borrow impacts its value.
Credit rating is always the most prevailing and significant measurement for corporate debt s default risk. The conception of single bankruptcy triggering threshold is the core of pricing theory for corporate debt and hence the capital

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