Did Government Regulations Lead to Inflated Credit Ratings?
Management Science 64(3), 1034-1054, 2018
55 Pages Posted: 23 Mar 2014 Last revised: 5 Nov 2018
Date Written: July 27, 2016
SEC regulations in 1975 gave select rating agencies increased market power by increasing both barriers to entry and the reliance on ratings for regulations. We test whether these regulations led to ratings inflation. We find that defaults and negative financial changes are more likely for firms given the same rating if the rating was assigned after the SEC action. Further, firms initially rated Baa post-regulations are 19% more likely to be negatively downgraded to speculative grade than firms rated Baa pre-regulations. These results indicate that the market power derived from the SEC led to ratings inflation.
Keywords: Credit ratings, SEC, Default risk, NRSROs, Capital markets regulation, Regulatory licensing
JEL Classification: G18, G24, G28, G32
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