A New Method for Credit-Enhancement Standards

A new approach, based on corporate bond default data, is proposed to determine the quantity of new equity capital a bond issuer must consistently raise (or the amount of current debt it must retire) to enhance its bond ratings. The current approach of the rating industry to determine such standards for upgrading bond ratings assumes that the probability of bond default by the issuer is unaffected by the new equity capital or retiring of debt. The specification in the new approach relaxes this assumption. The estimates show dramatically different standards for bond-rating upgrades between the approach suggested here and the standard industry approach.