Form or Substance? Incomplete Disambiguation of Credit Ratings in Syndicated Bank Loans

Abstract

Corporate credit ratings have tightened substantially and very gradually over two decades. We test whether the tightening has spillover effects in the market for syndicated loans. We find that this is indeed the case. Across several specifications, we find that loan spreads do not disambiguate ratings conservatism. The incomplete adjustment impacts the costs of bank borrowing, particularly for bank-dependent borrowers such as small firms or newly rated borrowers, who should benefit from being rated but incur higher borrowing costs because their bank loan spreads do not reflect their stricter credit ratings. Thus, frictions in the rating process find their way into other parts of the financial market because form - rather than substance alone - matters, even when institutional investors are the only participants in a marketplace.

Keywords: Credit ratings, ratings conservatism, syndicated loans, bank lending

JEL Classification: G21, G24, G14, G12