Do Regulations Based on Credit Ratings Affect a Firm's Cost of Capital?

Kisgen, Darren J.; Strahan, Philip E.

doi:10.1093/rfs/hhq077

Cited by 296 publications

(60 citation statements)

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“…Kisgen and Strahan (2009) investigated another form of entry when the SEC assigned NRSRO status to a fourth credit rating agency in the mid 1990s. The authors showed that the SEC's certification of the Dominion Bond Rating Service led to a statistically significant reduction in the cost of debt capital for the firms already rated by Dominion prior to its certification.…”

Section: Competition and The Quality Of Ratingsmentioning

confidence: 99%

Information effect of entry into credit ratings market: The case of insurers' ratings

Doherty

Kartasheva

Phillips

2012

Journal of Financial Economics

113

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The paper analyzes the effect of competition between credit rating agencies (CRAs) on the information content of ratings. We show that a monopolistic CRA pools sellers into multiple rating classes and has partial market coverage. This provides an opportunity for market entry. The entrant designs a rating scale distinct from that of the incumbent. It targets higher-than-average companies in each rating grade of the incumbent's rating scale and employs more stringent rating standards. We use Standard and Poor's (S&P) entry into the market for insurance ratings previously covered by a monopolist, A.M. Best, to empirically test the impact of entry on the information content of ratings. The empirical analysis reveals that S&P required higher standards to assign a rating similar to the one assigned by A.M. Best and that higher-than-average quality insurers in each rating category of A.M. Best chose to receive a second rating from S&P. Keywords ratings, competition, information disclosure, insurance Disciplines Economics | FinanceThis journal article is available at ScholarlyCommons: http://repository.upenn.edu/bepp_papers/121Electronic copy available at: http://ssrn.com/abstract=1101700Electronic copy available at: http://ssrn.com/abstract=1101700Information effect of entry into credit ratings market:The case of insurers' ratings * Neil A. Doherty † Anastasia V. Kartasheva ‡ Richard D. Phillips § August 21, 2011Abstract This paper analyzes the optimal entry strategy of a credit rating agency (CRA) to a market served by the incumbent. We show that a monopolistic CRA pools sellers into multiple rating classes and has partial market coverage. This provides an opportunity for market entry. The entrant targets higher-than-average companies in each rating class of the incumbent's rating scale and employs more stringent rating standards. We use Standard and Poor's entry into the market for insurance ratings previously covered by a monopolist, A.M. Best, to empirically test the impact of entry on the information content of ratings.Keywords: rating agency, entry, competition, precision and disclosure of information, insurance. 1Electronic copy available at: http://ssrn.com/abstract=1101700Electronic copy available at: http://ssrn.com/abstract=1101700Significant debate exists regarding the role that competition should play in the market for credit ratings. Representatives from the credit rating agencies (CRAs) themselves argue that reducing barriers to entry would eventually lead to reduced disclosure of information as the new entrants engage in "race to the bottom" strategies in order to sell Considering the unique dynamics of our market, historically new market entrants and marginal participants have sought to make their products more attractive to issuers by offering higher ratings than do more established market participants. Some new entrants might be inclined to try to compete in this manner because of the ease with which such a strategy could be implemented and the short-term benefits that might accrue to the en...

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Section: Competition and The Quality Of Ratingsmentioning

confidence: 99%

Information effect of entry into credit ratings market: The case of insurers' ratings

Doherty

Kartasheva

Phillips

2012

Journal of Financial Economics

113

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“…2 Incorporating the regulatory use of ratings into the analysis is appealing because there is extensive empirical evidence that regulatory implications of ratings are a first-order concern for marginal investors; that is, ratings affect market prices through the channel of regulation, independent of the information they provide about the riskiness of securities (Kisgen and Strahan, 2010;Ashcraft, Goldsmith-Pinkham, Hull, and Vickery, 2011).…”

Section: Introductionmentioning

confidence: 99%

Rating agencies in the face of regulation

Opp

Harris

2013

Journal of Financial Economics

326

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This paper develops a theoretical framework to shed light on variation in credit rating standards over time and across asset classes. Ratings issued by credit rating agencies serve a dual role: they provide information to investors and are used to regulate institutional investors. We show that introducing rating-contingent regulation that favors highly rated securities may increase or decrease rating informativeness, but unambiguously increases the volume of highly rated securities. If the regulatory advantage of highly rated securities is sufficiently large, delegated information acquisition is unsustainable, since the rating agency prefers to facilitate regulatory arbitrage by inflating ratings. Our model relates rating informativeness to the quality distribution of issuers, the complexity of assets, and issuers' outside options. We reconcile our results with the existing empirical literature and highlight new, testable implications, such as repercussions of the Dodd-Frank Act. AbstractThis paper develops a theoretical framework to shed light on variation in credit rating standards over time and across asset classes. Ratings issued by credit rating agencies serve a dual role: they provide information to investors and are used to regulate institutional investors. We show that introducing rating-contingent regulation that favors highly rated securities may increase or decrease rating informativeness, but unambiguously increases the volume of highly rated securities. If the regulatory advantage of highly rated securities is sufficiently large, delegated information acquisition is unsustainable, since the rating agency prefers to facilitate regulatory arbitrage by inflating ratings. Our model relates rating informativeness to the quality distribution of issuers, the complexity of assets, and issuers' outside options. We reconcile our results with the existing empirical literature and highlight new, testable implications, such as repercussions of the Dodd-Frank Act.

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“…Kisgen and Strahan (2009) show that ratings-based regulations affect a firm's cost of debt capital. If costs play an important role in CDS responses to rating actions, then the decrease in market reaction we observe would imply that rating actions are less costly to firms in the post-crisis era.…”

Section: Interpretation Of Resultsmentioning

confidence: 99%

“…At the investment-grade boundary, regulations based on credit ratings are most binding and ratings changes from investment-grade to high-yield are the most costly (Kisgen (2006) and Kisgen and Strahan (2009)). We include BD and CBD as no prior study has examined this issue in a cross-sectional analysis of CDS performance 25 .…”

Section: A1 Regression Specificationmentioning

confidence: 99%

The Credit Rating Crisis and the Informational Content of Corporate Credit Ratings

2010

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There has been much scrutiny of the Credit Rating Agencies' (CRAs) flawed ratings of structured products in the build-up to the financial crisis. Our study examines whether the 'credit rating crisis' altered the information effects of their traditional product, corporate bond rat- demonstrate that CDS price effects were considerably greater in the pre-crisis era, and document a possible spillover effect of reputational damage onto the bond rating services of the CRAs.

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Do Regulations Based on Credit Ratings Affect a Firm's Cost of Capital?

Cited by 296 publications

References 25 publications

Information effect of entry into credit ratings market: The case of insurers' ratings

Information effect of entry into credit ratings market: The case of insurers' ratings

Rating agencies in the face of regulation

The Credit Rating Crisis and the Informational Content of Corporate Credit Ratings

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