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Do Credit Ratings Affect Firm Investments? The Monitoring Role of Rating Agencies

40 Pages Posted: 25 Aug 2012  

Christina E. Bannier

Justus-Liebig-University Giessen

Christian W. Hirsch

University of Frankfurt; Goethe University Frankfurt - Research Center SAFE

M. Wiemann

Frankfurt School of Finance & Management

Date Written: July 17, 2012

Abstract

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.

Keywords: Credit rating, agency conflicts, investment, monitoring, rating competition

JEL Classification: G24, G32

Suggested Citation

Bannier, Christina E. and Hirsch, Christian W. and Wiemann, M., Do Credit Ratings Affect Firm Investments? The Monitoring Role of Rating Agencies (July 17, 2012). Available at SSRN: https://ssrn.com/abstract=2135483 or http://dx.doi.org/10.2139/ssrn.2135483

Christina E. Bannier (Contact Author)

Justus-Liebig-University Giessen ( email )

Licher Str. 62
Gießen, 35394
Germany
+49 641 99 22551 (Phone)

Christian W. Hirsch

University of Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany
+49 69 798 33704 (Phone)
+49 69 798 33901 (Fax)

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

M. Wiemann

Frankfurt School of Finance & Management ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

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