Credit Ratings

Paper Session

Friday, Jan. 6, 2017 10:15 AM – 12:15 PM

Sheraton Grand Chicago, Sheraton Ballroom III
Hosted By: American Finance Association
  • Chair: John Griffin, University of Texas-Austin

Where the Heart Is: Information Production and the Home Bias

Jess Cornaggia
,
Pennsylvania State University
Kimberly Cornaggia
,
Pennsylvania State University
Ryan Israelsen
,
Indiana University

Abstract

We examine credit ratings to shed new light on competing hypotheses in the home bias literature. We find that credit analysts who grew up in the state of the issuer award more favorable ratings than analysts who grew up outside the state. This effect is increasing in credit risk, reduces new issue credit spreads, and expands affected issuers’ debt capacity. Because this effect is driven by where analysts grew up, not by where they reside while producing ratings, we conclude that our results reflect home bias rather than superior information. Tests of timeliness and symmetry in rating updates by home and outside analysts further support this conclusion. We also find that analysts’ early life experiences influence the magnitude of the home bias. Overall, this paper shows that home bias exists among information producers, not just investors, and has real economic effects.

Non-Rating Revenue and Conflicts of Interest

Ramin Baghai
,
Stockholm School of Economics
Bo Becker
,
Stockholm School of Economics

Abstract

Rating agencies produce ratings used by investors, but obtain most of their revenue from issuers, both as ratings fees and as payment for other services. This leads to a potential conflict of interest. We employ a detailed panel data set on the use of non-rating<br />
services as well as payment flows between issuers and rating agencies in India to test if this conflict affects credit ratings. Rating agencies rate securities issued by<br />
companies that also hire them for non-rating services 0.3 notches higher (than agencies that are not paid for such services by the issuer). This effect is increasing in the<br />
revenue generated. We also find that, within rating categories, default rates are higher for firms that have paid for non-rating services. This suggests that the better rating that such firms receive does not reflect lower credit risk.

The Disciplining Effect of Credit Ratings: Evidence From Corporate Asset Sales

Dion Bongaerts
,
Erasmus University Rotterdam
Frederik-Paul Schlingemann
,
University of Pittsburgh

Abstract

We provide empirical evidence on the role credit rating agencies play as dedicated monitors. We find that firms are significantly more likely to conduct an asset sale following a credit rating downgrade. Shareholder wealth effects at the announcement of an asset sale and the likelihood of divesting relatively poorly performing assets is significantly higher when an asset sale is preceded by a credit rating downgrade. Our evidence suggests that rating downgrades affect managerial discipline as evidenced by more efficient capital allocation. We find only limited support for the argument that credit rating downgrades exacerbate financial distress.
Discussant(s)
Miguel Ferreira
,
Nova University of Lisbon
Jonathan Cohn
,
University of Texas-Austin
Mariassunta Giannetti
,
Stockholm School of Economics
JEL Classifications
  • G3 - Corporate Finance and Governance