Credit Rating Agencies and Accounting Fraud Detection

67 Pages Posted: 21 Aug 2019 Last revised: 16 Jul 2020

See all articles by Allen Huang

Allen Huang

Hong Kong University of Science and Technology - Department of Accounting

Pepa Kraft

HEC Paris

Shiheng Wang

Hong Kong University of Science & Technology (HKUST)

Date Written: August 14, 2019

Abstract

This study examines whether and when credit rating agencies take negative rating actions against issuers committing accounting fraud before the fraud is publicly revealed as well as the economic impacts of such rating actions. We find that Standard & Poor’s (S&P), an issuer-paid rating agency, downgrades fraud firms and puts them on negative credit watch as early as four quarters prior to public fraud revelation, controlling for firms’ economic fundamentals and performance. Furthermore, Egan-Jones, an investor-paid rating agency without access to management and private information, is much less timely than S&P in downgrading fraud firms, especially when information uncertainty is high. In addition, S&P distinguishes fraud firms from similar-looking non-fraud firms even when the former appears financially healthy, whereas Egan-Jones does not. This further supports that S&P’s private information advantage facilitates fraud detection. Finally, S&P’s negative rating actions against fraud firms inform the market and are associated with management turnover and shorter fraud duration.

Keywords: credit rating agency; accounting fraud; securities class-action lawsuits; issuer-paid rating agency; investor-paid rating agency; information uncertainty

JEL Classification: G24, K22, M41

Suggested Citation

Huang, Allen and Kraft, Pepa and Wang, Shiheng, Credit Rating Agencies and Accounting Fraud Detection (August 14, 2019). HEC Paris Research Paper No. ACC-2019-1348, Available at SSRN: https://ssrn.com/abstract=3438846 or http://dx.doi.org/10.2139/ssrn.3438846

Allen Huang (Contact Author)

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
HKUST
Clear Water Bay, Kowloon
Hong Kong
+852-23587559 (Phone)

HOME PAGE: http://www.AllenHuang.org

Pepa Kraft

HEC Paris ( email )

Jouy-en-Josas
France
644161543 (Phone)

HOME PAGE: http://www.hec.edu/Faculty-Research/Faculty-Directory/KRAFT-Pepa2

Shiheng Wang

Hong Kong University of Science & Technology (HKUST) ( email )

Clear Water Bay
Kowloon, 999999
Hong Kong
(852) 2358 7570 (Phone)
(852) 2358 1693 (Fax)

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