Cross-Listed Bonds, Information Asymmetry and Rating Conservatism

Abstract

We investigate whether rating conservatism increases with information asymmetry. We argue that high information asymmetry amplifies debtholders’ reliance on ratings for investment and contracting purposes, thus making rating agencies’ loss function more asymmetric and ratings more conservative. We exploit the greater information asymmetry of cross-listed bonds to test this hypothesis. Consistent with our expectation, we find that cross-listed bonds have lower initial ratings, are less likely to be upgraded, and take longer to be upgraded compared to U.S. domestic bonds with similar characteristics. While these results are consistent with rating conservatism, they are also consistent with rating agencies possessing private information that accurately reflects the higher risk of cross-listed bonds. To differentiate between these two explanations, we rely on three distinct tests and find results consistent with the rating conservatism and inconsistent with the private information explanation.

Keywords: cross-listed bonds, credit ratings, rating conservatism, cost of debt

JEL Classification: M41, G29, G38