Do Rating Agencies Behave Defensively for Higher Risk Issuers?

We examine whether rating agencies act defensively toward issuers with a higher likelihood of default. We find that agencies' qualitative soft rating adjustments are more accurate as issuers' default risk grows, as evidenced by the adjustments leading to lower type I and type II error rates and better prediction of default and default recovery losses. We also find that soft adjustments' relevance increases with issuers' default risk, as evidenced by the adjustments being more predictive of initial offering yields and leading to a greater market reaction to rating changes. Further, we find that the rating agencies assign better educated and more experienced analysts to higher-risk issuers, providing evidence of one mechanism used by the rating agencies to generate more accurate and relevant soft adjustments. Overall, our study suggests that as the likelihood of issuer default grows, the threat of reputational harm from discovered rating failures increasingly mitigates the rating agencies' strategic behavior incentivized by the issuer-pay model.

The final published version can be found at https://doi.org/10.1287/mnsc.2022.4537

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Work Title Do Rating Agencies Behave Defensively for Higher Risk Issuers?
Access
Open Access
Creators
  1. Samuel B. Bonsall
  2. Kevin Koharki
  3. Pepa Kraft
  4. Karl A. Muller
  5. Anywhere Sikochi
Keyword
  1. Credit rating agencies
  2. Soft rating adjustments
  3. Default
License In Copyright (Rights Reserved)
Work Type Article
Publisher
  1. Management Science
Publication Date September 15, 2022
Publisher Identifier (DOI)
  1. https://doi.org/10.1287/mnsc.2022.4537
Deposited March 11, 2024

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Version 1
published

  • Created
  • Added BKKMS_MS_01_27_2022.pdf
  • Added Creator Samuel B. Bonsall
  • Added Creator Kevin Koharki
  • Added Creator K A Muller
  • Added Creator Pepa Kraft
  • Added Creator Anywhere Sikochi
  • Added Creator Karl A Muller
  • Added Creator Anywhere Sikochi
  • Published
  • Updated Keyword, Publication Date Show Changes
    Keyword
    • Credit rating agencies, Soft rating adjustments, Default
    Publication Date
    • 2022-09-01
    • 2022-09-15
  • Deleted Creator K A Muller
  • Deleted Creator Anywhere Sikochi
  • Updated Creator Pepa Kraft
  • Renamed Creator Karl A. Muller Show Changes
    • Karl A Muller
    • Karl A. Muller
  • Updated