Credit Rating Inflation and Corporate Innovation

Abstract

Does credit rating quality affect corporate innovation? Using exogenous variation in rating quality that arises from competition among rating agencies, we show that firms with inflated ratings issue more patents, but their patent quality, as measured by scientific and economic value, declines. We provide evidence to show that managers engage in value-reducing patenting activity to exploit a compensation structure that rewards them for the number, but not the quality, of new patents. Our results are stronger in non-technology industries, which suggests that managers strategically exploit innovation when firms do not rely on patenting for value creation.

Keywords: Credit Rating Quality, Innovation, Compensation Packages

JEL Classification: G24, O31, J33