Credit Rating Agency and Equity Analysts' Adjustments to GAAP Earnings

Abstract:     
The adjusted earnings definitions of Moody’s are lower than those of sell-side equity analysts. The difference in the adjusted earnings definitions of the two financial intermediaries is greater when companies have more volatile stock returns or higher financial leverage. Furthermore, the difference in the adjusted earnings definitions is greater when Moody’s issues optimistic ratings for bonds that are subject to higher rating fee incentives. Moody’s earnings definitions more accurately predict future company earnings than those of sell-side equity analysts, though only for more poorly-rated firms. These findings indicate stronger conservatism incentives of credit rating agencies relative to equity analysts, especially under conditions of uncertainty and ratings optimism. Moreover, rating agencies’ relative conservatism does not appear to worsen the quality of their research output.

Number of Pages in PDF File: 38

Keywords: Analysts, Debt ratings, Street earnings, Conservatism

JEL Classification: M40

working papers series