Credit Ratings as Coordination Mechanisms

33 Pages Posted: 23 May 2002

See all articles by Arnoud W. A. Boot

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School

Multiple version iconThere are 2 versions of this paper

Date Written: April 2002

Abstract

In this Paper, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings can serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a 'focal point' for firms and their investors. We explore the vital - but previously overlooked - implicit contractual relationship between a credit rating agency and a firm. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of ratings changes, the discreteness in funding cost changes, and the effect of the focus of organizations on the efficacy of credit ratings.

Keywords: Credit ratings, multiple equilibria, coordination

JEL Classification: G23, G24, G32

Suggested Citation

Boot, Arnoud W. A. and Milbourn, Todd T., Credit Ratings as Coordination Mechanisms (April 2002). CEPR Discussion Paper No. 3331. Available at SSRN: https://ssrn.com/abstract=313647

Arnoud W. A. Boot (Contact Author)

University of Amsterdam - Amsterdam Business School ( email )

Roetersstraat 11
Amsterdam, 1018 WB
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+31 20 525 4162 (Phone)
+31 20 525 5318 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Todd T. Milbourn

Washington University in Saint Louis - Olin Business School ( email )

1 Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6392 (Phone)
314-935-6359 (Fax)

HOME PAGE: http://www.olin.wustl.edu/faculty/milbourn/

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