The Impact of Client Defaults on Inflated Rating of Credit Rating Agencies:Evidence from China

Abstract

This study examines whether issuer client defaults incentivize credit rating agencies (CRAs) to reduce inflated ratings. Using data of Chinese listed companies from 2010 to 2023, the empirical results indicate that when the issuers served by a CRA experiences more defaults, the CRA is more likely to alleviate inflated rating when serving other issuers. Further analysis reveals that state-owned enterprises are more significantly affected by defaults, which may be attributed to recent policy shifts and a decline in government bailout willingness in China. Additionally, the effect of defaults on reducing inflated rating is more pronounced for issuers with lower credit ratings and those geographically closer to the CRA. Overall, our findings suggest that client defaults exert a corrective impact on CRA behavior.

Keywords: Inflated Rating, Bond Default, Conflict of interest, Difference-in-Differences