What happens with the stock price of a company whose debt rating is downgraded?

What happens with the stock price of a company whose debt rating is downgraded? Please refer to a specific example in the last three years. Did the company recover? Was it able to actually service the debt? What happened with its stock price?

Expert Solution

Capital structure refers to the mix of a company's capitalization. That is a mix of long-term sources of funds through equity or Debt or both.

Debt Financing such as debentures, bonds.

Equity financing preference share capital, equity share capital and retained earnings.

Difference between Debt and Equity:

1. Debt has a maturity date of repayment and stock has no maturity date.

2. Incase of debt there is a legal obligation to pay interest, whereas there is no legal obligation to the dividend in case of equity.

If the companies debt instrument is downgraded. It means that company's ability to pay its debt holders is reduced.

In preference of payment debt is paid before Equity. If company can't even pay its debt holders then it is very unlikely that equity shares of the company will hold its value.

Hence value of equity decreases.

In past 3 years we can take example of Yesbank. Yesbank is Indian private bank.

The company's debt rating was downgraded. It was eventually unable to service its debt.

Its share price decreased from ₹400 in August 2018 to ₹12 in October 2020.

Government of India had to come & same Yesbank by help of public banks led by State Bank of India.

The company didn't recover but it is slowly in the process of recovering. Its too early to comment on this.

jeff jeffy answered 2 years ago

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