The Real Costs of Corporate Credit Ratings
Taylor A. Begley
London Business School
October 20, 2014
Paris December 2014 Finance Meeting EUROFIDAI - AFFI Paper
Credit rating agencies emphasize the importance of specific financial ratio thresholds in their rating process. Firms on the favorable side of these thresholds are more likely to receive higher ratings than similar firms that are not. I show that firms near these salient thresholds respond to the incentive to improve their appearance on this dimension by distorting real investment activities during periods leading up to bond issuance. These firms are significantly more likely to reduce R&D and SG&A expenditures compared to observationally similar firms not near a threshold. Subsequently, they are more likely to experience declines in innovation output, profitability, and Tobin's Q. These distortions highlight an important cost of arms-length financing and an adverse consequence of transparency in credit rating criteria.
Number of Pages in PDF File: 55
Keywords: credit ratings, transparency, real distortions
JEL Classification: G31
Date posted: March 4, 2014 ; Last revised: October 26, 2014
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