Do Security Analysts Discipline Credit Rating Agencies?

53 Pages Posted: 12 Dec 2011 Last revised: 20 Aug 2014

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

Date Written: August 18, 2014

Abstract

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.

Keywords: credit rating agencies, rating bias, competition

Suggested Citation

Fong, Kingsley Y. L. and Hong, Harrison G. and Kacperczyk, Marcin T. and Kubik, Jeffrey D., Do Security Analysts Discipline Credit Rating Agencies? (August 18, 2014). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1970963 or http://dx.doi.org/10.2139/ssrn.1970963

Kingsley Y. L. Fong

University of New South Wales - School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Marcin T. Kacperczyk (Contact Author)

Imperial College London - Accounting, Finance, and Macroeconomics ( email )

South Kensington campus
London SW7 2AZ
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jeffrey D. Kubik

Syracuse University - Department of Economics ( email )

426 Eggers Hall
Syracuse, NY 13244-1020
United States
315-443-9063 (Phone)
315-443-1081 (Fax)

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