Cross-country variations in capital structure adjustment-The role of credit ratings

•Capital structure is affected by credit ratings and the effect is asymmetric.•Firms expedite the adjustment speed when the ratings are downgraded.•The leverage ratios adjust faster in strong legal and institutional countries.•Legal and institutional issues are more important than rating change directions.

This paper investigates how cross-country variations in institutional variables affect the relationship between rating changes and firms' capital structure adjustment. Our results demonstrate first that the asymmetric effect exists, that is, firms adjust their capital structure when ratings are downgraded, but do not significantly adjust their leverage ratios when ratings are upgraded. Second, capital structure adjusts faster in countries with better financial development and strong legal and institutional environments than in weak ones, regardless of the upgraded and downgraded rating changes. Hence, the financial development and legal and institutional environments are more crucial in affecting the leverage ratio adjustments than the rating change directions.