Companies affected by a 2013 change in Moody’s treatment of perpetual preferred stock increased their total debt by more than 22% relative to matched peers, according to research showing that credit-rating methods can influence corporate borrowing and investment.
The paper, What’s in a Debt? Rating Agency Methodologies and Firms’ Financing and Investment Decisions, was written by Cesare Fracassi of the University of Texas at Austin and Gregory Weitzner of McGill University. It was published online as an accepted manuscript by The Review of Corporate Finance Studies on July 29, 2026.
It examines an unexpected change that Moody’s made on July 31, 2013. The change did not alter the companies’ accounting figures or automatically improve their credit ratings. It altered how Moody’s treated one type of security in its own leverage analysis.
Perpetual preferred stock received 100% equity credit
Preferred stock combines some characteristics of shares and bonds. The qualifying securities in the study were perpetual preferred shares with no debt claim in bankruptcy. Their dividends could also be suspended without triggering a debt default.
Before the rule change, Moody’s treated half of the value of these securities as debt and half as equity when assessing speculative-grade nonfinancial corporate issuers. After the change, it treated them as 100% equity.
For example, $100 million of qualifying preferred stock previously added $50 million to adjusted debt and $50 million to equity. Under the new method, the full $100 million counted as equity.
The rule applied to US public nonfinancial companies rated Ba1 or below by Moody’s. Of the 475 companies in that group, 44 held qualifying perpetual preferred stock and were directly affected.
Preferred stock represented an average of 9.6% of book capital at those companies. The methodological change mechanically reduced their average Moody’s-adjusted leverage from 61.9% to 57.1%, a decline of 4.8 percentage points.
The authors calculated that the reduction was slightly greater than the typical leverage difference associated with one rating notch. It was not an actual one-notch upgrade. Moody’s ratings for the affected companies did not change significantly after the firms responded.
Affected companies increased long-term debt
The researchers matched each affected company with four speculative-grade firms in the same industry that did not have preferred stock and had similar financial characteristics. Their main analysis covered four quarters before the rule change and eight quarters after it.
They estimate that total debt at the affected companies increased by more than 22% relative to the matched group. Long-term debt drove the increase, while the change in short-term debt was not statistically significant.
The response began quickly. The companies used approximately 30% of the newly available debt capacity within the first two months. Their Moody’s-adjusted leverage then moved gradually back towards its previous level, with most of the original gap gone after two years.
GAAP leverage, which was not mechanically changed by Moody’s methodology, rose by an estimated 3.1 percentage points relative to the control group. For the average affected company, that represented an increase from 57.1% to 60.2%. This estimate was less statistically precise than the debt result.
Property and total assets increased
The companies did not appear to use the additional borrowing simply to repurchase shares or pay larger dividends. The paper found no increase in either activity.
Instead, property, plant and equipment increased by approximately 8%, as did total assets, relative to matched firms. Both results were statistically significant.
The estimate for capital expenditure was approximately 10% higher, but it was not statistically significant. It should therefore not be presented as a confirmed increase in capital spending.
Taken together, the balance-sheet results indicate that the affected companies used the extra debt capacity to expand rather than merely replace equity with debt.
Share prices rose as credit spreads widened
Investors reacted differently depending on which part of the capital structure they owned.
During the five-day period from one trading day before the announcement through three days after it, the affected companies recorded a 2.8% cumulative abnormal share return relative to matched firms.
Over the same period, their credit spreads widened by 16.2 basis points, or approximately 3.5% from the starting average. A wider credit spread generally indicates that investors require more compensation to hold a company’s debt. The spread estimate was only marginally statistically significant and covered 22 affected companies for which suitable bond data were available.
The authors interpret the rise in share prices and the widening of credit spreads as consistent with value moving from existing debt holders to shareholders. They do not claim to have established that the companies’ total value fell.
Rating-linked contracts may explain the response
Many financial contracts contain provisions tied to credit ratings. A downgrade may increase interest costs, require additional collateral or give another party the right to demand repayment.
By reducing adjusted leverage, the methodology change may have created room for affected companies to borrow without crossing those rating-related thresholds. The firms could then take on more debt while moving back towards the leverage level Moody’s had measured before the change.
The researchers say their tests favour this relaxation of rating-linked constraints as the main explanation. However, they could not completely exclude other channels, including the possibility that investors interpreted the revised methodology as new information about creditworthiness.
A separate part of the study found that companies rated speculative-grade only by Moody’s almost tripled preferred stock as a share of capital relative to firms also or only rated speculative-grade by S&P. The finding suggests that rating methods can influence borrowing levels and the securities companies choose to issue.
The findings concern one specific rule change
The study uses a quasi-experimental comparison rather than a randomized trial. Its central group contained 44 highly leveraged US public companies with perpetual preferred stock, and the authors caution that financially unconstrained companies may respond differently.
The results therefore do not show that every rating-methodology change will cause every affected company to borrow more. They provide evidence from a specific event in which one group received additional capacity under Moody’s leverage measure while comparable firms did not.
For investors, the distinction between a rating and the method behind it matters. The US Securities and Exchange Commission says credit ratings are not investment advice or guarantees and should be considered alongside financial statements, prospectuses and other information.
Moody’s Investors Service is registered with the SEC as a nationally recognized statistical rating organization. The SEC examines registered agencies for compliance with applicable rules, but federal law prevents it from regulating the substance of their ratings or methodologies.
The study’s main business lesson is that a credit-rating method can affect the decisions it is intended to evaluate. In this case, changing how Moody’s counted one security was followed by more borrowing, larger balance sheets and a shift in the securities companies chose to issue.
