Partners in Wine: Entertainment and Credit Ratings

Abstract

Recent regulatory reforms seek to address conflicts of interest in the Chinese credit rating industry. Unlike U.S. companies, Chinese companies disclose entertainment expenses. We find a positive relation between abnormal entertainment expenses and ratings and this effect weakens after regulatory changes. Additional analyses based on local culture support a causal interpretation of the entertainment effect on ratings. Entertainment-driven ratings benefit firms via lower financing costs and increased debt capacity. These effects are distortionary, as firms with abnormal entertainment expenses do not default less. Overall, our findings suggest informal relationships facilitate rent seeking in an economy with weak institutions.

Keywords: Credit ratings, Entertainment expenditures, Informal Relationships

JEL Classification: G24, K49