Buying on Certification: Credit Ratings and Government Procurement

Abstract

We examine how credit ratings affect the public and private sectors differently by evaluating customer procurement decisions. Public-sector customers respond strongly to supplier rating changes: they increase purchases from upgraded firms and reduce purchases from downgraded firms. This response is not observed for the private sector. We show the magnitude of the government’s reaction is disproportionate to underlying credit risk, and is likely due to government agents’ desire to respond to ratings, a well-defined certification, to signal their decision-making is aligned with external assessment and to avoid reputational losses. Our paper highlights real effects of credit ratings on the public sector.

Keywords: Credit ratings, rating information, government procurement, public sector

JEL Classification: G24, G28, E62