The Economic Function of Credit Rating Agencies - What Does the Watchlist Tell Us?
Christian W. Hirsch
University of Frankfurt; Goethe University Frankfurt - House of Finance
Christina E. Bannier
Frankfurt School of Finance and Management
July 1, 2009
Credit rating agencies do not only disclose simple ratings but announce watchlists (rating reviews) and outlooks as well. This paper analyzes the economic function underlying the review procedure. Using Moody's rating data between 1982 and 2004, we find that for borrowers of high creditworthiness, rating agencies employ watchlists primarily in order to improve the delivery of information. For low-quality borrowers, in contrast, the review procedure seems to have developed into an implicit contract à la Boot et al. (2006), inducing the companies "on watch'' to abstain from risk-augmenting actions. The agencies' economic role hence appears to have been enhanced from a pure information certification towards an active monitoring function.
Number of Pages in PDF File: 37
Keywords: Credit Rating Agencies, Credit Rating, Watchlist, Rating Review, Event Study
JEL Classification: G14, G24, G33working papers series
Date posted: February 17, 2009 ; Last revised: January 14, 2010
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