The New Rules of the Rating Game: Market Perception of Corporate Ratings

Abstract

We investigate how the informativeness of rating changes varies in different economic and regulatory environments, using the financial crisis and the Dodd-Frank Act as structural changes in the context of the US corporate bond market. Our analysis focuses on testing various hypotheses based on existing models of rating agency behavior. Informativeness is measured through the impact of credit rating changes on the prices and liquidity of corporate bonds, taking differences in their characteristics into account. We find that the informativeness of rating changes is low when the economy is booming and regulation favors better-rated securities, especially when their cost of information acquisition is high. In economic downturns, the informativeness increases in combination with a high level of illiquidity. After the introduction of Dodd-Frank, rating changes became more informative, but not for securities with high information costs and low underlying credit risk.JEL-Classification: G01, G12, G24

An empirical analysis of the effects of the Dodd–Frank Act on determinants of credit ratings

“…Second, we shed light on the mixed results in prior studies concerning rating quality changes after the Dodd–Frank period (e.g., deHaan, 2017; Dimitrov et al., 2015; Jankowitsch et al., 2022; Toscano, 2020). The weighting of quantitative, fundamental information in determining ratings is a potential mechanism that can alter rating quality or performance.…”

“…Third, following prior literature (deHaan, 2017; Jankowitsch et al. (2022); Toscano, 2020), we test rating determinants and default predictability during the financial crisis and post‐Dodd–Frank periods. Finally, we perform cross‐sectional analyses to show that our results are unlikely to be driven by increased public scrutiny measured by media attention due to the financial crisis.…”

Does credit rating conservatism matter for corporate tax avoidance?

“…et al (2017) find that actual ratings assigned by CRAs are lower than the predicted ratings which are assumed to be the ratings that would have been observed had Dodd-Frank not been passed. Jankowitsch et al (2018) find that CRAs are now more reluctant to upgrade bonds since Dodd-Frank, as a consequence of the potential litigation risk in the event of a lawsuit.…”

The Credit Rating Agencies and Their Role in the Financial System

“…25 However, there is a growing body of evidence that greater competition among CRAs for the rating business of even plain vanilla issuers does lead to some modest catering to issuersbut not the large-scale catering that occurred in rating RMBS. For summaries of this recent literature, see Flynn and Ghent (2018); Jankowitsch et al (2017); Cornaggia et al (2017); Bruno et al (2016); and Cornaggia and Cornaggia (2013). 26 More detail on these points can be found in White (2013White ( , 2016.…”