How Do Global Credit-Rating Agencies Rate Firms from Developing Countries?

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. This paper seeks the relative contribution of sovereign risks and firm-level credit risks in a firm's rating assignment. The findings reveal that sovereign risks contribute to a major part of firms' ratings in developing countries, whereas such risks play a negligible role in assigning ratings in developed countries. Terms of use: Documents inThe authors show that this result for developing countries partly depends on the "country ceiling effect"-private ratings are bound upwards by their sovereign rating-but in these countries idiosyncratic information is irrelevant even for firms whose rating would lie anyhow well below their sovereign. They also document that the information content of firm ratings is much smaller in developing countries than in developed countries. Finally, the paper suggests that cross-country indicators of information quality, rule of law and other institutional quality indicators help explain this unsatisfactory situation but do not solve the puzzle entirely. ADB Institute Research Paper SeriesNo. 26 III PREFACEThe ADB Institute aims to explore the most appropriate development paradigms for Asia composed of well-balanced combinations of the roles of markets, institutions, and governments in the post-crisis period.Under this broad research project on development paradigms, the ADB Institute Research Paper Series will contribute to disseminating works -in-progress as a building block of the project and will invite comments and questions.I trust that this series will provoke constructive discussions among policymakers as well as researchers about where Asian economies should go from the last crisis and current recovery. Masaru Yoshitomi Dean ADB Institute IV ABSTRACTWhat is the relative contribution of sovereign risks and firm-level credit risks in a firm's rating assignment? Or, stated otherwise, what is the information content of these components in a firm's rating? This paper intends to examine this issue, which has not been adequately addressed so far, using a tailor-made firm-level database, matching sovereign and firm ratings with firm performance indicators reportedly used by rating agencies. The paper decomposes factors contributing to a firm's credit rating by measuring each factor's relative weight. By matching a firm's credit risk indicators with its corresponding sovereign risk, we are able to disentangle the relative importance of each factor in a firm's rating assignment.We make three contributions. First, our findings ...

Asymmetric benchmarking in bank credit rating

“…Specifically, nations with good rule of law receive better ratings, yet so too do those with poor creditor protection. Ferri and Liu (2004) examined a sample of 563 non-financial firms from 45 countries and found that in developed countries, financial ratios can comprise almost all the information content of firm credit ratings, while in developing countries, ratings are heavily dependent on sovereign risks and financial ratios play a negligible role. They also found that the quality of institutions (proxied by the rule of law index) and of information disclosure can partly explain differences in rating behavior.…”

“…Specifically, Ball et al (2000), Hung (2001), and Leuz et al (2003) highlight that a country's legal and institutional environment can affect firms' financial reporting incentives and hence influence the quality of financial information reported to outside investors. The literature also indicates that countries with stronger rule of law and higher quality of information disclosure receive better ratings (Purda, 2003;Ferri and Liu, 2004). The evidence presented by Demirgüç -Kunt and Detragiache (1998) suggests that improved institutional environment quality reduces the likelihood of bank crisis when it is proxied by the law and order index.…”

“…Next, our bank rating model uses the most comprehensive data set from 86 countries during 2002-2008. By contrast, previous studies use less number of sample countries and the focus is on non-financial firms (Ferri et al, 2001;Ferri and Liu, 2004;Purda, 2003;Poon, 2003). While Poon and Firth (2005) and Poon et al (2009) investigate banks ratings, their focus is on whether unsolicited ratings are downward bias.…”

“…For example, Rojas-Suarez (2001) discussed the asymmetric information but did not proceed empirical studies. Ferri and Liu (2004) found non-financial firm ratings are explained by institutional quality but did not directly explore the information asymmetry, nor did they use banking sample. Next, our bank rating model uses the most comprehensive data set from 86 countries during 2002-2008.…”

Popular Attitudes, Globalization and Risk*

“…Although departures from this practice have increased, it is still a relatively rare phenomenon, and some research suggests that in the case of developing countries, sovereign ratings continue to exert a strong influence on the ratings assigned to non-sovereign borrowers (Ferri and Liu 2003). Although departures from this practice have increased, it is still a relatively rare phenomenon, and some research suggests that in the case of developing countries, sovereign ratings continue to exert a strong influence on the ratings assigned to non-sovereign borrowers (Ferri and Liu 2003).…”