Credit Rating Agencies and Accounting Fraud Detection

59 Pages Posted: 21 Aug 2019 Last revised: 25 Sep 2019

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 (CRAs) take negative rating actions against issuers committing accounting fraud before the fraud is publicly revealed and the economic impact of such rating actions. Our findings show that these fraud firms experience a greater number of negative rating actions during the four quarters prior to the public fraud revelation, including lower ratings, more rating downgrades, and more negative credit watch additions, compared to firms with similar economic fundamentals and stock performance. Our findings also show that such negative rating actions are not limited to fraud firms in financial distress, suggesting that our effect reflects CRA responses to accounting fraud per se. In addition, we find CRAs take more timely actions when frauds are more severe, when they involve accounts more often scrutinized by CRAs during their credit analysis, and when short sellers target firms. Last, we find that CRAs’ negative rating actions against fraud firms are informative to the market and are associated with shorter fraud duration. Overall, we conclude that CRAs possess private information about accounting fraud prior to the public revelation of this fraud and that they incorporate this information into negative ratings actions, accelerating fraud discovery.

Keywords: credit rating agency, accounting fraud, rating actions, securities class action lawsuits

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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