Credit Rating Agencies and Accounting Fraud Detection

62 Pages Posted: 21 Aug 2019 Last revised: 7 Sep 2021

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 that commit accounting fraud before the fraud is publicly revealed and investigates the economic effects of such rating actions. After controlling for firms’ economic fundamentals and other sources of information, we find that Standard & Poor’s (S&P), an issuer-paid rating agency, takes negative rating actions against fraud firms, including downgrades and negative credit watches, as early as four quarters before the revelation of fraud. Egan-Jones, an investor-paid rating agency with no access to management and material nonpublic information, is slower than S&P to downgrade fraud firms, especially when information uncertainty is high and when fraud firms are subject to private SEC investigations. Last, we find that S&P’s negative rating actions against fraud firms are informative to the market and are associated with a shorter fraud duration. Taken together, our results suggest that credit rating agencies use their information advantage to detect accounting fraud.

Keywords: credit rating agency; accounting fraud; 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

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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