The Real Effects of Rating Inflation: Evidence from the Chinese Corporate Credit Ratings

41 Pages Posted: 13 Oct 2020

See all articles by Shida Liu

Shida Liu

Tsinghua University - School of Economics & Management

Hao Wang

Tsinghua University

Date Written: August 22, 2020

Abstract

Holding firm fundamentals constant, credit ratings of the Chinese firms have increased by one notch on average during 2009-2017. The rating standard relaxation coincides with rating inflation, as the feedback effects of higher ratings that help reduce financing cost and improve investment and future credit quality can only explain a small portion of the rating hikes. Aided by partially reduced debt costs, the more inflated firms have higher leverage, hold less cash, and invest more in capital assets but not research and development. They exhibit moderately higher risk but no improvements to growth, profitability and efficiency. Regulatory arbitrage and conflict of interest rooted in the issuer-pays business model play prominent roles in explaining the rating inflation.

Keywords: Rating inflation, rating standard, regulatory arbitrage, feedback effects, China.

JEL Classification: G21, G24, G28

Suggested Citation

Liu, Shida and Wang, Hao, The Real Effects of Rating Inflation: Evidence from the Chinese Corporate Credit Ratings (August 22, 2020). Available at SSRN: https://ssrn.com/abstract=3680291 or http://dx.doi.org/10.2139/ssrn.3680291

Shida Liu (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

Hao Wang

Tsinghua University ( email )

318 Weilun Building
Tsinghua University
Beijing, 100084
China
86 10 62797482 (Phone)
86 10 62794554 (Fax)

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