IS A BOND RATING DOWNGRADE BAD-NEWS, GOOD-NEWS, OR NO NEWS FOR STOCKHOLDERS

We examine the reaction of common stock returns to bond rating changes . While recent studies find a significant negative stock response to d owngrades, we argue that this reaction should not be expected for all downgrades because: (1) some rating changes are anticipated by market participants and (2) downgrades because of an anticipated move to tran sfer wealth from bondholders to stockholders should be good news for s tockholders. We find that downgrades associated with deteriorating fin ancial prospects convey new negative information to the capital market , but that downgrades due to changes in firms' leverage do not.