Accounting - Theses
Permanent URI for this collection
Search Results
1 - 1 of 1
-
ItemThe Impact of Increased Credit Rating Quality on Rated Firms( 2020)Following the subprime mortgage crisis of 2007-2008, credit rating agencies (CRAs) faced scathing criticisms from the media and regulators for their role in the unfolding of the Global Financial Crisis (FC). The ensuing reputational damage and the changes to the regulation of CRAs led them to make numerous changes to their rating standards. Several prior studies have since examined the impact of these changes on rating quality, documenting tighter rating standards, lower ratings, and a change in rating quality after the FC. Despite these findings, however, little is understood about how a change in rating quality affects rated firms, and how firms respond to such a change. Using the tightening of rating standards in the wake of the FC as the main setting, this thesis seeks to explore these questions. Given the private lenders’ frequent use of ratings in performance pricing provisions and setting interest rates, the first study explores the changes in two dimensions of debt contracting: the use of rating-based performance pricing provisions, also called rating triggers, and loan spreads. Results suggest that the decline in the use of rating triggers in the post-FC period as documented in deHaan (2017) is muted in cases where the increase in rating quality was likely to be high, and is stronger in loans originated by lenders that had high reputational concerns. Closer inspection of pricing grids reveals that, consistent with lenders perceiving ratings to be more informative after the FC, rating downgrades/upgrades move loan spreads to a greater extent in the post-FC period. Evidence from tests on initial loan spreads provides support to this finding, but is generally weaker. These findings contribute to our understanding of how an increase in rating quality affects rated firms through its impact on debt contracting. That higher rating quality is associated with more likely downgrades suggests that firms have incentives to respond to an increase in rating quality due to the importance of ratings for firms’ debt policy. Accordingly, in light of the theoretical guidance and related empirical evidence, the second study examines whether rated firms increase misreporting in response to an increase in rating quality. In empirical tests, I find that accrual-based earnings management increased in rated firms in the post-FC period, and that this increase was driven by firms with rating triggers. In tests motivated by the CRAs’ adjustments to firms’ earnings, I also find that firms facing stronger CRA monitoring managed financial numbers that feed into these adjustments to a greater extent in the post-FC period. Considering the information used by CRAs in the rating process comes primarily from financial statements, this study informs regulators regarding the unintended consequences of regulatory reforms that aim to improve overall rating quality. The final study continues exploring other dimensions of firms’ responses to increased rating quality with an emphasis on real firm decisions. Results from tests examining real earnings management proxies indicate no change in the post-FC period for any of the numerous proxies examined. In tests motivated by the S&P’s rating criteria, however, I find that rated firms increased their excess cash holdings to a greater extent than non-rated firms after the FC. Results suggest this effect was stronger for firms placed under negative credit watch. Taken together, these findings expand our understanding of firms’ responses to an increase in rating quality by providing evidence on the impact of increased rating quality on real firm decisions.