Do Security Analysts Discipline Credit Rating Agencies?
Kingsley Y. L. Fong
University of New South Wales - School of Banking and Finance; Financial Research Network (FIRN)
Harrison G. Hong
Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)
Marcin T. Kacperczyk
Imperial College London - Accounting, Finance, and Macroeconomics; National Bureau of Economic Research (NBER)
Jeffrey D. Kubik
Syracuse University - Department of Economics
August 18, 2014
AFA 2013 San Diego Meetings Paper
Earlier work exploiting brokerage house mergers identified that security analyst coverage leads to more competitive and less optimistically biased earnings forecasts. Since the earnings forecasts for a firm’s equity enter directly into the credit ratings of a firm’s debt, we test the hypothesis that security analyst coverage also disciplines credit rating agencies. We indeed find that a drop in analyst coverage due to these mergers leads to greater optimism-bias in credit ratings, especially for firms with little bond analyst coverage to begin with and for firms that are close to default. This coverage-induced shock leads to less informative ratings about future defaults and downgrades, and more subsequent bond security mispricings. Even though analysts do not directly compete with credit rating agencies, analyst reports about a firm’s equity nonetheless discipline what credit rating agencies can say about the firm’s debt.
Number of Pages in PDF File: 53
Keywords: credit rating agencies, rating bias, competition
Date posted: December 12, 2011 ; Last revised: August 20, 2014