The Real Consequences of Market Segmentation

We study the real effects of market segmentation due to credit ratings by using a matched sample of firms just above and just below the investment-grade cutoff. These firms have similar observables, including average investment rates. However, flows into high-yield mutual funds have an economically significant effect on the issuance and investment of the speculative-grade firms relative to their matches, especially for firms likely to be financially constrained. The effect is associated with the discrete change in label from investment- to speculative-grade, not with changes in continuous measures of credit quality. We do not find similar effects at other rating boundaries. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.