Do Rating Agencies Behave Defensively for Higher Risk Issuers?

Samuel B. Bonsall, Kevin Koharki, Pepa Kraft, Karl A. Muller, Anywhere Sikochi

Research output: Contribution to journalArticlepeer-review

2 Scopus citations

Abstract

We examine whether rating agencies act defensively toward issuers with a higher likelihood of default. We find that agencies' qualitative soft rating adjustments are more accurate as issuers' default risk grows, as evidenced by the adjustments leading to lower type I and type II error rates and better prediction of default and default recovery losses. We also find that soft adjustments' relevance increases with issuers' default risk, as evidenced by the adjustments being more predictive of initial offering yields and leading to a greater market reaction to rating changes. Further, we find that the rating agencies assign better educated and more experienced analysts to higher-risk issuers, providing evidence of one mechanism used by the rating agencies to generate more accurate and relevant soft adjustments. Overall, our study suggests that as the likelihood of issuer default grows, the threat of reputational harm from discovered rating failures increasingly mitigates the rating agencies' strategic behavior incentivized by the issuer-pay model.

Original languageEnglish (US)
Pages (from-to)4864-4887
Number of pages24
JournalManagement Science
Volume69
Issue number8
DOIs
StatePublished - Aug 2023

All Science Journal Classification (ASJC) codes

  • Strategy and Management
  • Management Science and Operations Research

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