Does the Dodd-Frank Act Reduce the Conflict of Interests of Credit Rating Agencies?

Posted: 1 Sep 2016 Last revised: 12 Sep 2016

See all articles by Francesca Toscano

Francesca Toscano

Wayne State University - Mike Ilitch School of Business

Date Written: August 30, 2016

Abstract

This paper compares the behavior of standard or issuer-paid rating agencies (represented by Standard & Poor's, S&P) to alternative or investor-paid rating agencies (represented by the Egan and Jones Rating company, EJR) after the passage of the Dodd-Frank Act. Results show that both S&P and EJR ratings are more conservative, stable and, on average, lower after the Dodd-Frank regulation. However, EJR ratings are higher for firms that potentially may generate a high revenue. Additionally, I find that, after the regulation, S&P cares more about its reputation. Exploiting a measure that captures the bond market ability to anticipate rating downgrades, I show that, after Dodd-Frank, bond market anticipation decreases for S&P but increases for EJR suggesting that S&P ratings are timilier. Finally, the paper studies how the bond market responds to rating changes and how firms perceive ratings in their decision of debt issuance in the post Dodd-Frank period. Results suggest that both S&P downgrades and upgrades generate a greater bond market response. On the contrary, only EJR upgrades have a magnified effect on bond market returns. The greater informativeness of S&P ratings after Dodd-Frank is confirmed by the meaningful impact of these ratings on firm debt issuance.

Keywords: Dodd-Frank, Credit Ratings, Reputation, Issuer-paid, Investor-paid, Conflicts of Interest, Market Anticipation

JEL Classification: G01, G14, G24, G28

Suggested Citation

Toscano, Francesca, Does the Dodd-Frank Act Reduce the Conflict of Interests of Credit Rating Agencies? (August 30, 2016). Available at SSRN: https://ssrn.com/abstract=2832182

Francesca Toscano (Contact Author)

Wayne State University - Mike Ilitch School of Business ( email )

2771 Woodward Ave
Detroit, MI 48201
United States

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