The Impact of Credit Ratings on Capital Markets

40 Pages Posted: 2 Nov 2018

See all articles by Spyros Terovitis

Spyros Terovitis

University of Amsterdam, Finance Group

Date Written: September 5, 2018

Abstract

We develop a model of investment financing which is characterized by the interplay of information asymmetry regarding the project's productivity and lack of commitment about the allocation of productive resources. This environment gives rise to a feedback effect between managerial actions and the creditors' beliefs about them. We find that informative credit ratings alleviate the information asymmetry between the manager of a rm and its creditors, but strengthen (on average) the incentive to withdraw productive resources from the project, and subsequently default. We characterize the conditions under which informative credit ratings worsen financing opportunities and lead to a higher expected probability of default and cost of capital. Finally, we study the implications for the regulation of credit rating agencies.

Keywords: Information Disclosure, Credit Rating Agencies, Feedback Effect, Financial Regulation

JEL Classification: D82, D83, G24

Suggested Citation

Terovitis, Spyros, The Impact of Credit Ratings on Capital Markets (September 5, 2018). Available at SSRN: https://ssrn.com/abstract=3260650 or http://dx.doi.org/10.2139/ssrn.3260650

Spyros Terovitis (Contact Author)

University of Amsterdam, Finance Group ( email )

M3.04, Amsterdam Business School
Plantage Muidergracht 12
Amsterdam, 1018TV
Netherlands

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