Ratings Quality and Borrowing Choice
71 Pages Posted: 18 Sep 2015 Last revised: 9 Jan 2019
Date Written: December 18, 2018
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: Suggested Citation