The adjustment of credit ratings in advance of defaults

This paper assesses biases in credit ratings and lead–lag relationships for near-to-default issuers with multiple ratings by Moody’s and S&P. Based on defaults from 1997 to 2004, we find evidence that Moody’s seems to adjust its ratings to increasing default risk in a timelier manner than S&P. Second, credit ratings by the two US-based agencies are not subject to any home preference. Third, given a downgrade (upgrade) by the first rating agency, subsequent downgrades (upgrades) by the second rating agency are of greater magnitude in the short term. Fourth, harsher rating changes by one agency are followed by harsher rating changes in the same direction by the second agency. Fifth, rating changes by the second rating agency are significantly more likely after downgrades than after upgrades by the first rating agency. Additionally, we find evidence for serial correlation in rating changes up to 90 days subsequent to the rating change of interest after controlling for rating changes by the second rating agency.     

Can investor-paid credit rating agencies improve the information quality of issuer-paid rating agencies?

This paper examines how the information quality of ratings from an issuer-paid rating agency (Standard and Poor's) responds to the entry of an investor-paid rating agency, the Egan-Jones Rating Company (EJR). By comparing S&P's ratings quality before and after EJR initiates coverage of each firm, I find a significant improvement in S&P's ratings quality following EJR's coverage initiation. S&P's ratings become more responsive to credit risk and its rating changes incorporate higher information content. These results differ from the existing literature documenting a deterioration in the incumbents' ratings quality following the entry of a third issuer-paid agency. I further show that the issuer-paid agency seems to improve the ratings quality because EJR's coverage has elevated its reputational concerns.     

How rating agencies achieve rating stability

Surveys on the use of agency credit ratings reveal that some investors believe that rating agencies are relatively slow in adjusting their ratings. A well-accepted explanation for this perception on the timeliness of ratings is the through-the-cycle methodology that agencies use. According to Moody’s, through-the-cycle ratings are stable because they are intended to measure default risk over long investment horizons, and because they are changed only when agencies are confident that observed changes in a company’s risk profile are likely to be permanent. To verify this explanation, we quantify the impact of the long-term default horizon and the prudent migration policy on rating stability from the perspective of an investor – with no desire for rating stability. This is done by benchmarking agency ratings with a financial ratio-based (credit-scoring) agency-rating prediction model and (credit-scoring) default-prediction models of various time horizons. We also examine rating-migration practices. The final result is a better quantitative understanding of the through-the-cycle methodology.By varying the time horizon in the estimation of default-prediction models, we search for a best match with the agency-rating prediction model. Consistent with the agencies’ stated objectives, we conclude that agency ratings are focused on the long term. In contrast to one-year default prediction models, agency ratings place less weight on short-term indicators of credit quality.We also demonstrate that the focus of agencies on long investment horizons explains only part of the relative stability of agency ratings. The other aspect of through-the-cycle methodology – agency-rating migration policy – is an even more important factor underlying the stability of agency ratings. We find that rating migrations are triggered when the difference between the actual agency rating and the model predicted rating exceeds a certain threshold level. When rating migrations are triggered, agencies adjust their ratings only partially, consistent with the known serial dependency of agency-rating migrations.     

Sovereign ceilings “lite”? The impact of sovereign ratings on corporate ratings

Although credit rating agencies have gradually moved away from a policy of never rating a corporation above the sovereign (the ‘sovereign ceiling’), it appears that sovereign credit ratings remain a significant determinant of corporate credit ratings. We examine this link using data for advanced and emerging economies over the period of 1995–2009. Our main result is that a sovereign ceiling continues to affect the rating of corporations. The results also suggest that the influence of a sovereign ceiling on corporate ratings remains particularly significant in countries where capital account restrictions are still in place and with high political risk.     

Rating agencies and the role of rating publication rights

While credit rating agencies disclose all public ratings as a matter of policy, a firm can choose whether to make a so called private rating public or to keep it confidential. This paper analyzes the economic role of such rating publication rights. In particular, the paper tries to answer the following two questions: (1) If firms have scope to disclose agency ratings at their own discretion, can they use this discretion strategically and conceal low-quality ratings?, and (2), if this is the case, what are the economic implications for rated firms, unrated firms and the rating agency, resulting from strategically motivated selective rating disclosures? Using a theoretical model, it is shown that an equilibrium with partial nondisclosure of low-quality ratings can emerge whenever investors cannot be sure whether rating nondisclosure is due to the firm being not rated, or due to the rating’s adverse content. Moreover, since from an investors’ perspective, strategically acting rated firms and unrated firms are pooled, unrated firms’ debt is always under-valued (compared to a situation in which investors know that the firm is not rated), and the debt of firms concealing their rating is always over-valued.     

Timeliness of Spread Implied Ratings

Rating agencies are known to be prudent in their approach to rating revisions, which results in delayed rating adjustments. For a large set of eurobonds we derive credit spread implied ratings and compare them with agency ratings. Our results indicate that spread implied ratings often anticipate the future movement of agency ratings and hence can help track credit risk in a more timely manner. This finding has important implications for risk managers in banks who, under the new Basel 2 regulations, have to rely more on credit ratings for capital allocation purposes, and for portfolio managers who face rating‐related investment restrictions.     

Credit rating dynamics and Markov mixture models

Despite mounting evidence to the contrary, credit migration matrices, used in many credit risk and pricing applications, are typically assumed to be generated by a simple Markov process. Based on empirical evidence, we propose a parsimonious model that is a mixture of (two) Markov chains, where the mixing is on the speed of movement among credit ratings. We estimate this model using credit rating histories and show that the mixture model statistically dominates the simple Markov model and that the differences between two models can be economically meaningful. The non-Markov property of our model implies that the future distribution of a firm’s ratings depends not only on its current rating but also on its past rating history. Indeed we find that two firms with identical current credit ratings can have substantially different transition probability vectors. We also find that conditioning on the state of the business cycle or industry group does not remove the heterogeneity with respect to the rate of movement. We go on to compare the performance of mixture and Markov chain using out-of-sample predictions.     

Managerial ability and bond rating changes

This study examines the relation between managerial ability and bond credit rating changes. We attempt to add to the credit rating agency literature by exploring the role managerial ability plays in the initial bond rating assignments and in rating changes. We predict firms with more‐able managers are more likely to have higher bond ratings and to be more able to have a positive influence on rating changes. We find a significant and positive relation between managerial ability and change in credit ratings, suggesting that more‐able managers can take effective actions to improve their credit ratings.     

How did increased competition affect credit ratings?

The credit rating industry has historically been dominated by just two agencies, Moody's and Standard & Poor's, leading to long-standing legislative and regulatory calls for increased competition. The material entry of a third rating agency (Fitch) to the competitive landscape offers a unique experiment to empirically examine how increased competition affects the credit ratings market. What we find is relatively troubling. Specifically, we discover that increased competition from Fitch coincides with lower quality ratings from the incumbents: Rating levels went up, the correlation between ratings and market-implied yields fell, and the ability of ratings to predict default deteriorated. We offer several possible explanations for these findings that are linked to existing theories.     

The impact of sovereign rating actions on bank ratings in emerging markets

This paper analyses the effects of sovereign rating actions on the credit ratings of banks in emerging markets, using a sample from three global rating agencies across 54 countries for 1999–2009. Despite widespread attention to sovereign ratings and bank ratings, no previous study has investigated the link in this manner. We find that sovereign rating upgrades (downgrades) have strong effects on bank rating upgrades (downgrades). The impact of sovereign watch status on bank rating actions is much weaker and often insignificant. The sensitivity of banks’ ratings to sovereign rating actions is affected by the countries’ economic and financial freedom and by macroeconomic conditions. Ratings of banks with different ownership structures are all influenced strongly by the sovereign rating, with some variation depending on the countries’ characteristics. Emerging market bank ratings are less likely to follow sovereign rating downgrades during the recent financial crisis period.     

“投资人付费”vs.“发行人付费”:谁的信用评级质量更高？

本文选择2011-2015年被中债资信覆盖的发债A股上市公司作为主要研究对象,比较了“投资人付费”与“发行人付费”模式下的评级质量高低。研究发现:(1)与“发行人付费”评级相比,采用“投资人付费”模式的中债资信所作评级显著更低。(2)与“发行人付费”评级相比,当采用“投资人付费”模式的中债资信所作评级越低时,发行人未来盈利能力越差、预期违约风险越高,投资者要求的风险补偿也越高,这表明“投资人付费”模式下的信用评级质量更高。(3)“发行人付费”模式的评级结果可以在一定程度上反映公司的内部私有信息,但由于同时存在独立性缺失问题,“发行人付费”模式的信用评级质量仍然不如“投资人付费”模式的信用评级质量,这说明独立性对于评级机构尤其重要。     

Do Rating Agencies Benefit from Providing Higher Ratings? Evidence from the Consequences of Municipal Bond Ratings Recalibration

We ask whether credit rating agencies receive higher fees and gain greater market share when they provide more favorable ratings. To investigate this question, we use the 2010 rating scale recalibration by Moody's and Fitch, which increased ratings absent any underlying change in issuer credit quality. Consistent with prior research, we find that the recalibration allowed the clients of Moody's and Fitch to receive better ratings and lower yields. We add to this evidence by showing that the recalibration also led to larger fees and to increases in the market shares of Moody's and Fitch. These results are consistent with critics’ concerns about the effects of the issuer‐pay model on the credit ratings market.     

Rating Agency Reputation,the Global Financial Crisis,and the Cost of Debt

Why do foreign firms obtain credit ratings by global rating agencies rather than from their home country's rating agencies even though global raters typically assign lower credit ratings when these foreign firms issue bonds in their home currencies? We find that bonds rated by a global agency decreased yields 11‐14 basis points (bps) when compared to those rated by Japanese rating agencies but, during the 2007‐2009 financial crisis, the yields on these Japanese bonds increased 12‐17 bps, thus fully negating the advantage of obtaining a bond rating from a global rater. This suggests that the reputation of global rating agencies declined during the 2007‐2009 crisis period.     

How do sovereign credit rating changes affect private investment?

Sovereign credit rating changes have an influence on real private investment of re-rated countries. We find significant increases in private investment growth following upgrades in sovereign ratings. These increases, however, are transitory. We also find significant, temporary declines in private investment growth following sovereign rating downgrades. The results hold after accounting for re-rated countries’ growth opportunities, endogeneity, and other factors that could affect private investment. The irreversible nature of investment may be the explanation for the temporary changes in the growth rates of physical capital investment associated with revisions in sovereign credit ratings.     

Regulation of credit rating agencies

Financial regulators recognize certain credit rating agencies for regulatory purposes. However, it is often argued that credit rating agencies have an incentive to assign inflated ratings. This paper studies a repeated principal-agent problem in which a regulator approves credit rating agencies. Credit rating agencies may collude to assign inflated ratings. Yet we show that there exists an approval scheme which induces credit rating agencies to assign correct ratings.     

The sovereign-bank rating channel and rating agencies' downgrades during the European debt crisis

We investigate the rating channel for the transmission of changes in sovereign risk to the banking sector, analysing data from Moody's, S&P and Fitch before and during the European debt crisis. Sovereign rating downgrades and negative watch signals have strong effects on bank rating downgrades in the crisis period. The impact is stronger for multiple-notch sovereign rating downgrades, and more pronounced in PIIGS countries. Secondly, we investigate rating agencies' competition in the banking sector during the same periods, finding significant differences in rating policies across the agencies. S&P credit actions tend to be the more independent ones, while Moody's appears to be more cautious, although it is by far the most likely to assign multiple-notch downgrades. In the pre-crisis period, we find no evidence that bank rating actions are linked to sovereign rating signals (nor vice versa) nor to prior bank rating changes by a competing agency.     

Leads and lags in sovereign credit ratings

This paper analyses lead–lag relationships in sovereign ratings across five agencies, and finds evidence of interdependence in rating actions. Upgrade (downgrade) probabilities are much higher, and downgrade (upgrade) probabilities are much lower for a sovereign issuer with a recent upgrade (downgrade) by another agency. S&P tends to demonstrate the least dependence on other agencies, and Moody’s tends to be the first mover in upgrades. Rating actions by Japanese agencies tend to lag those of the larger agencies, although there is some evidence that they lead Moody’s downgrades.     

Feedback effects of credit ratings

Rating agencies are often criticized for being biased in favor of borrowers, for being too slow to downgrade following credit quality deterioration, and for being oligopolists. Based on a model that takes into account the feedback effects of credit ratings, I show that: (i) rating agencies should focus not only on the accuracy of their ratings but also on the effects of their ratings on the probability of survival of the borrower; (ii) even when rating agencies pursue an accurate rating policy, multi-notch downgrades or immediate default may occur in response to small shocks to fundamentals; (iii) increased competition between rating agencies can lead to rating downgrades, increasing default frequency and reducing welfare.     

Sovereign credit ratings and financial markets linkages: Application to European data

We use EU sovereign bond yield and CDS spreads daily data to carry out an event study analysis on the reaction of government yield spreads before and after announcements from rating agencies (Standard & Poor’s, Moody’s, Fitch). Our results show significant responses of government bond yield spreads to changes in rating notations and outlook, particularly in the case of negative announcements. Announcements are not anticipated at 1–2 months horizon but there is bi-directional causality between ratings and spreads within 1–2 weeks; spillover effects especially among EMU countries and from lower rated countries to higher rated countries; and persistence effects for recently downgraded countries.     

The economic function of credit rating agencies – What does the watchlist tell us?

Credit rating agencies do not only disclose simple ratings but announce watchlists (rating reviews) and outlooks as well. This paper analyzes the economic function underlying the review procedure. Using Moody’s rating data between 1982 and 2004, we find that for borrowers of high creditworthiness, rating agencies employ watchlists primarily in order to improve the delivery of information. For low-quality borrowers, in contrast, the review procedure seems to have developed into an implicit contract á la Boot et al. (2006), inducing the companies “on watch” to abstain from risk-augmenting actions. The agencies’ economic role hence appears to have been enhanced from a pure information certification towards an active monitoring function.