Compensation Incentives of Credit Rating Agencies and Predictability of Changes in Bond Ratings and Financial Strength Ratings

48 Pages Posted: 26 Sep 2012 Last revised: 3 May 2013

See all articles by Andreas Milidonis

Andreas Milidonis

University of Cyprus - Department of Accounting and Finance

Date Written: April 1, 2013

Abstract

Over the past decade there has been mixed evidence on the lead-lag relation between issuer-paid and investor-paid credit rating agencies. We investigate the lead-lag relationship for changes in bond ratings (BRs) and financial strength ratings (FSRs), for the US insurance industry, where FSRs impose market discipline. First, we find that changes in issuer-paid BRs are led by changes in investor-paid BRs, even over a period that issuer-paid agencies have improved their timeliness. Second, information flows in both directions between changes in issuer-paid BRs and FSRs. Third, issuer-paid FSRs are predictable by investor-paid BRs. Fourth, the lead effect of investor-paid downgrades is economically significant as it is associated with an unconditional, post-event, thirty-day cumulative abnormal return of -4%. This return is a result of investor-paid downgrades in BRs, which predict more downgrades in the following ninety days (same period return of -11%).

Keywords: credit rating agencies, information dissemination, timeliness, predictability, insurance

JEL Classification: G14, G22, G24

Suggested Citation

Milidonis, Andreas, Compensation Incentives of Credit Rating Agencies and Predictability of Changes in Bond Ratings and Financial Strength Ratings (April 1, 2013). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2151686 or http://dx.doi.org/10.2139/ssrn.2151686

Andreas Milidonis (Contact Author)

University of Cyprus - Department of Accounting and Finance ( email )

P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 22 893 626 (Phone)

HOME PAGE: http://www.ucy.ac.cy/~amilidon/

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