We investigate the impact of credit ratings on the valuation of diversification. Our empirical results indicate that the existence and level of credit ratings are associated with a lower negative effect of diversification. Further analysis reveals that the mitigating effect of credit ratings on the diversification discount is more pronounced for firms with more severe information asymmetry. In addition, both a change in firm status from no rating to being rated and a change in rating level from low to high lead to a significant reduction in the diversification discount. An event study on diversification buttresses the findings by showing that the market has a less negative reaction to rated and higher-rated firms around the announcement of diversifying mergers. Our results are robust to alternative techniques used to control for potential endogeneity bias, to controlling for corporate governance, and to different sample periods. Overall, the evidence suggests that credit ratings reduce information asymmetry problems and thus mitigate the diversification discount.
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