Unexpected Bond Ratings and the Cost of Municipal Debt

53 Pages Posted: 14 Sep 2020

See all articles by Amanda Beck

Amanda Beck

Georgia State University

Linda M. Parsons

University of Alabama - Culverhouse School of Accountancy

Trevor Sorensen

West Virginia University - Department of Accounting and Management Information Systems

Date Written: July 31, 2020

Abstract

We investigate whether credit rating agencies (CRAs) and investors price the extent to which municipal bond ratings are explainable using public information. We use an ordinal logistic regression to estimate the expected and unexpected portions of bond ratings, and find that both CRA fees and yield premiums are higher for negative unexplained (i.e., pessimistic) ratings. CRA fees are not generally associated with positive unexplained (i.e., optimistic) ratings, although we document a positive association when financial reporting quality or investor sophistication is low. While creditors price both pessimistic and optimistic unexplained ratings, yield premiums for pessimistic ratings are significantly greater than yield discounts for optimistic ratings. These findings manifest after the passage of the Dodd-Frank Act, among sophisticated investors, and among municipalities with high financial reporting quality. We contribute to research that examines the determinants of municipal debt costs, CRA fees, and the information content of bond ratings.

Keywords: municipal bonds, bond ratings, credit rating agencies, credit rating fees

JEL Classification: G12, G24, G28, D82, H74, M40, M41

Suggested Citation

Beck, Amanda and Parsons, Linda M. and Sorensen, Trevor, Unexpected Bond Ratings and the Cost of Municipal Debt (July 31, 2020). Available at SSRN: https://ssrn.com/abstract=3664916 or http://dx.doi.org/10.2139/ssrn.3664916

Amanda Beck (Contact Author)

Georgia State University ( email )

P.O. Box 4050
Atlanta, GA 30302-4050
United States

Linda M. Parsons

University of Alabama - Culverhouse School of Accountancy ( email )

101 Paul W. Bryant Dr.
Box 870382
Tuscaloosa, AL 35487
United States

Trevor Sorensen

West Virginia University - Department of Accounting and Management Information Systems ( email )

Morgantown, WV 26506
United States

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