Buying on Certification: Customer Procurement and Credit Ratings

Abstract

We examine how credit ratings affect firm stakeholders, in particular, customers in the supply chain. We find that changes to suppliers’ credit rating produce dramatically different effects on customer procurement depending on the type of customer. The public sector (i.e., federal government) responds strongly to supplier rating changes: it increases purchases from upgraded firms, and reduces purchases from downgraded firms. In sharp contrast, private sector (non-government) customers do not exhibit such a significant response. We find this contrast is likely due to government agents’ reliance on credit ratings as a verifiable certification to signal competence through procurement decisions and avoid reputational risk. We also find suggestive evidence that powerful politicians might utilize ratings to direct government contracts to suppliers located in states they represent. While existing studies largely document how public sector spending influences private sector corporations, our findings highlight how public sector spending can be influenced by private sector credit ratings.

Keywords: Government procurement, Customers, Supply-customer chain, rating certification, credit ratings

JEL Classification: G24, G28, E62