The Determinants and Consequences of Financial Thresholds in Credit Ratings

We introduce new evidence on how financial ratio-based thresholds, an increasingly common feature of credit rating disclosures since the Great Financial Crisis, affect firm behavior and market perceptions. Using a novel dataset extracted from over 20,000 S&P credit reports from 2008 to 2020, we show that these thresholds, now disclosed in 75% of all credit rating reports, are neither mechanical nor symbolic. First, threshold levels reflect both firm fundamentals and credit rating agency (CRA) incentives: they are tighter for riskier firms and looser when CRAs’ reputational concerns are lower or conflicts of interest are more salient. Second, thresholds influence real outcomes: firms facing tighter benchmarks cut leverage, preserve equity, and improve performance, especially among speculative-grade issuers. Third, threshold breaches are meaningful signals that predict negative rating actions. These findings demonstrate that ratio-based thresholds, although non-binding, serve as soft constraints and public signals, offering a key mechanism through which CRAs discipline issuers and coordinate expectations in capital markets.