Credit Rating Changes and Earnings Management

We examine whether firm managers engage in income‐increasing accruals manipulation or real activities earnings management to affect the future rating changes when firm managers have private information about the upcoming credit rating change. Using the large sample of United States data over the period 1990–2011, we find that firms with upcoming credit rating changes are likely to engage in real activities earnings management, whereas they tend to decrease discretionary accruals before credit rating changes. We also find a positive relationship between real activities management (RM) and credit rating upgrades, but no relation between RM and downgrades. The findings suggest that the firm's management tries to influence the upcoming changes of credit ratings by actively engaging in real activities earnings management rather than accruals‐based earnings management.