Does Reputational Capital Affect Credit Rating Agencies?: Empirical Evidence from a Natural Experiment in China

Abstract

The subprime mortgage crisis of 2007-2008 has led major economies to reform their credit rating regulations, and China is not an exception. This paper employs a difference-in-difference research design to investigate whether reputational capital affects credit rating agencies. The first market-oriented evaluation of the Chinese inter-bank bond market is chosen as the source of the exogenous reputational shock. Using the medium term notes rated by China Chengxin International Credit Rating as benchmarks, we identify a causal relationship revealing that the average yield spread at the issuance of medium term notes, as rated by China Lianhe Credit Rating, increases by between 0.22% and 0.33% percent due to its decreased reputational capital. Our research provides favorable evidence for the recent reform measures that aim to increase the disciplinary power of reputational capital.

Keywords: Chinese Debt Market; Credit Rating Agencies; Difference-in-Difference; Inter-bank Bond Market; Medium Term Note; Reputational Capital

JEL Classification: G01; G14; G24; G28