Ratings Quality and Borrowing Choice

71 Pages Posted: 18 Sep 2015 Last revised: 9 Jan 2019

See all articles by Dominique C. Badoer

Dominique C. Badoer

University of Illinois at Chicago - Department of Finance

Cem Demiroglu

Koc University, College of Administrative Sciences and Economics

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: December 18, 2018

Abstract

Past studies document that incentive conflicts may lead issuer-paid credit rating agencies to provide optimistically-biased ratings. In this paper, we present evidence that investors question the quality of issuer-paid ratings and raise corporate bond yields where the issuer-paid rating is more positive than benchmark investor-paid ratings. We also find that some firms with favorable issuer-paid ratings substitute public bonds with borrowings from informed intermediaries to mitigate the “lemons discount” associated with poor quality ratings. Overall, our results suggest that the quality of issuer-paid ratings has significant effects on borrowing costs and choice of debt.

Keywords: credit ratings; ratings inflation; asymmetric information

JEL Classification: G14, G24, G32

Suggested Citation

Badoer, Dominique C. and Demiroglu, Cem and James, Christopher M., Ratings Quality and Borrowing Choice (December 18, 2018). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2661397 or http://dx.doi.org/10.2139/ssrn.2661397

Dominique C. Badoer

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

Cem Demiroglu (Contact Author)

Koc University, College of Administrative Sciences and Economics ( email )

Koc University
Sariyer
Istanbul, 34450
Turkey
90-212-338-1620 (Phone)
90-212-338-1653 (Fax)

HOME PAGE: http://https://sites.google.com/site/cemdemiroglu/

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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