An Empirical Analysis of the Effects of the Dodd-Frank Act on Determinants of Credit Ratings

Posted: 26 Jun 2017

See all articles by Anwer S. Ahmed

Anwer S. Ahmed

Texas A&M University - Mays Business School

Dechun Wang

Texas A&M University

Nina Xu

Texas A&M University - Department of Accounting

Date Written: June 23, 2017

Abstract

We study the effects of the Dodd-Frank Act (“Dodd-Frank”) on determinants of credit ratings. We predict that the increase in regulatory oversight and litigation risk prompted by Dodd-Frank, as well as requirements for improved disclosures and governance, motivated credit rating agencies (CRAs) to increase the weight on firm-specific, quantitative fundamental information in making rating decisions. We find that CRAs place a higher weight on firm-specific fundamentals in determining ratings, and the power of the fundamentals in explaining credit rating variation increases significantly after the passage of Dodd-Frank. Additionally, we find that the greater reliance on firm fundamentals at least partially drives the improvement in credit ratings’ ability to predict future defaults. Finally, we show that Dodd-Frank has an incremental effect beyond the financial crisis on the determinants of credit ratings. Our results are robust to a battery of sensitivity analyses. Collectively, our evidence suggests that Dodd-Frank incentivizes CRAs to use more quantitative information in making rating decisions, which in turn helps improve credit rating quality.

Keywords: Dodd-Frank Act; Fundamental information; Credit rating; Default prediction

JEL Classification: G380; K220; M400

Suggested Citation

Ahmed, Anwer S. and Wang, Dechun and Xu, Nina, An Empirical Analysis of the Effects of the Dodd-Frank Act on Determinants of Credit Ratings (June 23, 2017). Available at SSRN: https://ssrn.com/abstract=2991922 or http://dx.doi.org/10.2139/ssrn.2991922

Anwer S. Ahmed

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Dechun Wang (Contact Author)

Texas A&M University ( email )

430 Wehner
College Station, TX 77843-4353
United States

Nina Xu

Texas A&M University - Department of Accounting ( email )

430 Wehner
College Station, TX 77843-4353
United States

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