Do Security Analysts Discipline Credit Rating Agencies?

Abstract:     
We test the hypothesis that security analysts discipline credit rating agencies. After all, analyst reports about a firm’s equity would no doubt be informative about its debt default probability and calibrate its credit ratings. We use brokerage house mergers, which eliminate redundant analysts, to shock analyst following so as to identify the causal effect of coverage on credit ratings. We find that a drop in one analyst covering increases the subsequent ratings of a company by around a significant half-rating notch. This effect is coming largely from firms with low initial analyst coverage and hence where the loss of one analyst is a sizeable percentage drop in market discipline. Our effect is stronger for firms close to default and hence where firm debt trades more like equity. The higher ratings due to fewer analysts following also result in lower bond yields.

Number of Pages in PDF File: 43

Keywords: credit rating agencies, rating bias, competition

working papers series