Credit Rating Inflation and Firms' Investments

We analyze credit rating effects on firm investments in a rational bond financing game that features a feedback loop. The credit rating agency (CRA) inflates the rating, providing a biased but informative signal to creditors. Creditors' response to the rating affects the firm's investment decision and thus its credit quality, which is reflected in the rating. The CRA might reduce ex ante economic efficiency, which results solely from its strategic effect: the CRA assigns more firms high ratings and allows them to gamble for resurrection. We derive empirical predictions on the determinants of rating standards and inflation and discuss policy implications.     

Market share and risk taking: the role of collateral asset managers in the collapse of the arbitrage CDO market

Asset pricing theory predicts that if credit ratings do not reflect all relevant aspects of a CDO debt tranche’s risk profile (i.e., its total and systematic risk), then ratings-based tranche pricing by some naïve investors creates incentives for CDO arrangers to take excessive non-priced risk. CDO managers’ desire for repeat issuance makes them part of this risk taking strategy to exploit naïve investors. The implication is that the credit quality of CDOs run by large market share managers has a higher tendency to deteriorate in bad times. This paper finds empirical evidence for large market share manager’s conflicts of interest.     

Fiscal-audit separation and government disclosure quality

We show that the separation of the fiscal and audit offices of China’s province-level governments leads to high fiscal disclosure quality, an effect that is more pronounced when the political rank of the official in charge of auditing is higher than that of the official in charge of fiscal matters. Dynamically, disclosure quality decreases when fiscal office and audit office go from being separated to being integrated and improves when they go from being integrated to being separated. Finally, fiscal disclosure quality reduces the cost of debt and improves credit ratings of municipal investment and development bonds. We demonstrate an aspect of China’s governance that, even without adequate monitoring from the oppositions or the media, local governments can improve efficiency via horizontal separations of fiscal and audit offices.     

Are banks happy when managers go long? The information content of managers’ vested option holdings for loan pricing

While traditional finance theory holds that managers with option-laden incentive contracts may favor equity at the expense of debt, a risk-averse manager may be more likely to retain vested in-the-money options if the manager has private information that the firm's risk-adjusted performance will be better. It follows that vested option holdings should be positively associated with credit quality. In support of this, we find that vested option holdings have a strong negative association with loan pricing, especially for informationally sensitive loans, and also predict higher cash flows and credit ratings, a greater distance to default, and lower equity volatility.     

Bad Times,Good Credit

Banks’ limited knowledge about borrowers’ creditworthiness constitutes an important friction in credit markets. Is this friction deeper in recessions, thereby contributing to cyclical swings in credit, or is the friction reduced, as bad times reveal information about firm quality? We test these alternative hypotheses using internal ratings data from a large Swedish cross-border bank and credit scores from a credit bureau. The ability to classify corporate borrowers by credit quality is greater during bad times and worse during good times. Soft and hard information measures both display countercyclical patterns. Our results suggest that information frictions in corporate credit markets are intrinsically countercyclical and not due to cyclical variation in monitoring effort. The presence of countercyclical information frictions provides a rationale for countercyclical provisions or capital in banks to smooth credit cycles.     

Director Networks and Credit Ratings

We explore the effect of director social capital, directors with large and influential networks, on credit ratings. Using a sample of 11,172 firm‐year observations from 1999 to 2011, we find that larger board networks are associated with higher credit ratings than both firm financial data and probabilities of default predict. Near‐investment grade firms improve their forward‐looking ratings when their board is more connected. Last, we find that larger director networks are more beneficial during recessions, and times of increased financial uncertainty. Our results are robust to controls for endogeneity. Tests confirm that causality runs from connected boards to credit ratings.     

MANAGING FOR RATINGS: REAL EFFECTS OF A CORPORATE RATINGS CRITERIA CHANGE

We exploit a criteria change by Standard & Poor's (S&P) to examine the real effects of a credit ratings change. Using a recalibration by S&P, unrelated to firms’ fundamentals, as a quasi-natural experiment we analyze the impact of a ratings upgrade on the issuance activity, investment, cash holdings, and payout policy of companies. Our findings suggest upgraded firms subsequently issue more debt relative to equity, enjoy lower debt yields, and increase their investment rate and share repurchases. We find limited evidence that upgraded firms decrease their cash holdings. Our results support the view that credit ratings have a real effect on corporations.     

“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.     

Capital Budgeting in Multidivision Firms: Information, Agency, and Incentives

We examine optimal capital allocation and managerial compensationin a firm with two investment projects (divisions) each runby a risk-neutral manager who can provide (i) (unverifiable)information about project quality and (ii) (unverifiable) accessto value-enhancing, but privately costly resources. The optimalmanagerial compensation contract offers greater performancepay and a lower salary when managers report that their projectis higher quality. The firm generally underinvests in capitaland managers underutilize resources (relative to first-best).We also derive cross-sectional predictions about the sensitivityof investment in one division to the quality of investment opportunitiesin the other division, and the relative importance of division-leveland firm-level performance-based pay in managerial compensationcontracts.     

Equilibrium earnings management and managerial compensation in a multiperiod agency setting

To investigate how the possibility of earnings manipulation affects managerial compensation contracts, we study a two-period agency setting in which a firm’s manager can engage in window-dressing activities to manipulate reported accounting earnings. Earnings manipulation boosts the reported earnings in one period at the expense of the reported earnings in the other period. We find that the optimal pay-performance sensitivity may increase and expected managerial compensation may decrease as the manager’s cost of earnings management decreases. When the manager is privately informed about the payoff of an investment project to the firm, we identify plausible conditions under which prohibiting earnings management can result in a less efficient investment decision for the firm and more rents for the manager.     

国家主权信用评级质量检验方法研究

国家主权信用评级对当今国际经济和金融运行有着极为重要的影响力。但是,与其地位不相符的是,评级机构的评级结果事后多次被证明准确性和前瞻性较差。事先缺乏预警而事后大幅降级,甚至对加剧危机起到了推波助澜的作用。本文从国家主权信用评级质量的检验方法入手,系统分析了违约率和迁移率等传统方法在检验评级结果起到的作用及其不足,给出了检验评级质量的一般方法,并验证了该评级检验方法的科学性和准确性。     

Market-implied ratings and their divergence from credit ratings

In this article, we investigate the divergence between credit ratings (CRs) and Moody's market-implied ratings (MIRs). Our evidence shows that rating gaps provide incremental information to the market regarding issuers' default risk over CRs alone in the short horizon and outperform CRs over extended horizons. The predictive ability of rating gaps is greater for more opaque and volatile issuers. Such predictability was more pronounced during the 2008 financial crisis but weakened in the post–Dodd–Frank Act period. This finding is consistent with credit rating agencies’ efforts to improve their performance when facing regulatory pressure. Moreover, our analysis identifies rating-gap signals that do (do not) lead to subsequent Moody's actions to place issuers on negative outlook and watchlists. We find that negative signals from MIR gaps have a real economic impact on issuers’ fundamentals such as profitability, leverage, investment, and default risk, thus supporting the recovery-efforts hypothesis.     

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.     

Credit ratings and acquisitions

There is a curvilinear relation between credit ratings and acquisitions. Non-investment grade firms make more acquisitions as their ratings improve, consistent with the relaxation of financial constraints. However, this pattern reverses for investment grade firms, supporting the view that such firms want to preserve their rating and are concerned about acquisition-related downgrades. Abnormal returns first decrease and then increase as ratings improve. In support of these findings, acquisitions have a negative impact on future ratings only for highly-rated firms. These results indicate that the level of a firm's credit rating has a significant impact on the acquisition process.     

The Value of Mandatory Certification: A Real Effects Perspective

We study the real effects of certification to demonstrate the value of mandatory certification over and above mandatory disclosure in enhancing investment efficiency. In our model, a firm's manager selects a project to maximize the firm's short-term stock price, which is a function of her certification and disclosure decisions about the outcome of the project. Although the manager might be either forthcoming or strategic with regard to the disclosure of her private information, she can strategically choose whether to incur a cost or not to certify her disclosure, unless mandated. The manager always selects the first-best project when both certification and disclosure are mandatory. However, when certification is voluntary, project selection is inefficient. In addition, mandating disclosure without mandating certification can lead to lower investment efficiency than mandating neither. In justifying why mandatory certification is beneficial for public firms, our results offer a note of caution regarding the contemplated regulatory moves for increased disclosures by public firms without corresponding certification requirements, for example, the recent SEC proposal requiring extensive climate-related disclosure.     

Do Sovereign Re‐Ratings Destabilize Equity Markets during Financial Crises? New Evidence from Higher Return Moments

This study investigates the effects of S&P's sovereign re‐ratings on the higher moments of equity market returns over recent financial crises. Using a set of intraday stock market index prices and sovereign credit ratings for a sample of 36 countries that experienced sovereign rating changes over the period from 1996 to 2013, we find that the higher moments of stock market returns are significantly more responsive to sovereign re‐ratings during financial crises, but the effects on stock markets are not the same across different financial crises. The effects during crises are, however, magnified for large downgrades and those that are associated with a loss of investment grade status. We find that there are asymmetric effects during financial crises in that downgrades are consistently more significant than upgrades in increasing realized volatility and realized kurtosis. Both upgrades and downgrades affect realized skewness in times of crises in the expected direction.     

The role of credit ratings on capital structure and its speed of adjustment: an international study

Using an international dataset, we examine the role of issuers’ credit ratings in explaining corporate leverage and the speed with which firms adjust toward their optimal level of leverage. We find that, in countries with a more market-oriented financial system, the impact of credit ratings on firms’ capital structure is more significant and that firms with a poorer credit rating adjust more rapidly. Furthermore, our results show some striking differences in the speed of adjusting capital structure between firms rated as speculative and investment grade, with the former adjusting much more rapidly. As hypothesized, those differences are statistically significant only for firms based in a more market-oriented economy.     

Debt Financing and Voluntary Adoption of the International Financial Reporting Standards: Evidence from Korean Unlisted Firms

We investigate the effect of debt financing on the voluntary adoption of the International Financial Reporting Standards (IFRS) by unlisted firms and such adoption’s effect on bond credit rating. We find that unlisted firms with public debts are more likely to voluntarily adopt IFRS. Subsequent to the voluntary application of IFRS, the unlisted firms exhibit, on average, enhanced credit ratings. These findings suggest that the public debt market’s demand for high-quality financial reporting may drive those unlisted firms to voluntarily adopt IFRS. Furthermore, rating agencies seem to reward such firms by elevating their bond credit ratings.     

Ratings versus market-based measures of default risk in portfolio governance

This paper assesses whether ratings or market-based credit risk measures are more suitable for formulating portfolio governance rules. Such rules, which consist of buy and sell restrictions, are commonly used in investment management. Based on data from 1983 to 2002, it is not evident that one of the two measures is superior. The relative power of the two measures in predicting defaults depend on the investor’s investment horizon and risk appetite. The results support the agencies’ claim that their policy of reducing rating volatility, which builds on the though-the-cycle approach and the avoidance of frequent rating reversals, is beneficial to bond investors. The results also suggest that widely used statistical measures of rating quality may be insufficient to judge the economic value of rating information in specific contexts.