Do Credit Ratings Affect Firm Investments? The Monitoring Role of Rating Agencies
Christina E. Bannier
Christian W. Hirsch
University of Frankfurt; Goethe University Frankfurt - House of Finance
Frankfurt School of Finance & Management
July 17, 2012
Agency conflicts may induce managers to choose inefficiently risky investment projects that benefit stockholders at the expense of debtholders. While private debt contracts often contain covenants restricting investment choices, public debt rarely does. We therefore examine whether credit rating agencies exercise a disciplining function on behalf of the bondholders. We show that, indeed, firms reduce (raise) their investment rates around negative (positive) rating events. This investment reaction is independent of changes in performance, investment opportunities, capital costs, or target rating strategies. It is strongest for firms with high agency conflicts. We also demonstrate that increasing competition among credit rating agencies reduces the monitoring effect. Higher rating competition, fostered by regulatory action, might therefore harm the beneficial and so far unrecognized real impact of the industry.
Number of Pages in PDF File: 40
Keywords: Credit rating, agency conflicts, investment, monitoring, rating competition
JEL Classification: G24, G32
Date posted: August 25, 2012
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