Expected Legal Liability, the Number of Financial Statement Information Signals, and Credit Ratings’ Quality

Abstract

This study uses passage of the Dodd-Frank Act as a setting to examine whether increased expected legal liability exposure faced by credit rating agencies affect the number of financial statement information signals required before rating changes. For upgrades, we predict and find that the expected greater legal exposure after the Act incentivized rating agencies to require more information signals. This effect is concentrated among firms in industries with high litigation risk. In addition, the greater required number of information signals resulted in improved upgrades quality. In contrast, the Act had little influence on the downgrade decision.

Keywords: Dodd-Frank Act, Financial statement information, Credit rating quality

JEL Classification: G3, G24