When Credit Rating Agencies Avoid Downgrading: The Effects of Performance-Sensitive Debt

44 Pages Posted: 13 May 2020

See all articles by Christoph Herpfer

Christoph Herpfer

Emory University - Goizueta Business School

Gonzalo Maturana

Emory University - Goizueta Business School

Date Written: April 17, 2020

Abstract

Credit rating inflation in securitized products was a major contributor to the Financial Crisis. The major credit rating agencies (CRAs) subsequently settled with the U.S. government for yielding to conflicts of interest, and they renewed their commitment to credit rating quality. We study the $900 billion performance-sensitive debt market, in which interest rates are a dynamic function of credit ratings. Using detailed data on loan pricing schedules, we show that credit rating inflation is prevalent in this market, and credit rating inflation remained unchanged after the settlements. In the presence of competing CRAs, rating inflation is stronger for a CRA when its rating is decisive in determining interest rates. Our results are not driven by firms hiding negative information from CRAs, and they are not driven by CRAs catering to investors at the border of the investment grade classification. Moreover, the potential for credit inflation is priced at origination, indicating that borrowers and lenders are aware of the CRAs' conflicts of interest.

Keywords: Credit Ratings, Performance-Sensitive Debt, Pricing Grid, Rating Catering

JEL Classification: G14, G24, G28, G32

Suggested Citation

Herpfer, Christoph and Maturana, Gonzalo, When Credit Rating Agencies Avoid Downgrading: The Effects of Performance-Sensitive Debt (April 17, 2020). Available at SSRN: https://ssrn.com/abstract=3579030 or http://dx.doi.org/10.2139/ssrn.3579030

Christoph Herpfer

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

Gonzalo Maturana (Contact Author)

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

HOME PAGE: http://www.gonzalomaturana.com/

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