“Does the Dodd-Frank Act Reduce the Conflicts of Interest Faced by Credit Rating Agencies?”
This paper compares the behavior of standard or issuer-paid rating agencies, represented by Standard & Poor’s (S&P) to alternative or investor-paid rating agencies, represented by the Egan-Jones Ratings Company (EJR) after the Dodd-Frank Act regulation is approved. Results show that both S&P and EJR ratings are more conservative, stable and, on average, lower after the Dodd-Frank implementation. However, EJR ratings are higher for firms that may generate high revenue for the rater. Additionally, I find that, after the regulation, S&P cares more about its reputation. Exploiting a measure that captures the bond market’s ability to anticipate rating downgrades, I show that, after Dodd-Frank, bond market’s anticipation decreases for S&P but increases for EJR, suggesting that S&P ratings are timelier. Finally, I study how the bond market responds to rating changes and how firms perceive ratings in their decision to issue debt in the post-Dodd-Frank period. Results suggest that both S&P downgrades and upgrades generate a greater bond market response. On the contrary, only EJR upgrades have a magnified effect on bond market returns. The greater informativeness of S&P ratings after Dodd-Frank is confirmed by the meaningful impact of these ratings on firm debt issuance.
“CEO Turnover and Credit Rating Changes: Theory and Evidence”
with Anna Maria C. Menichini (University of Salerno and CSEF)
We study the relationship between credit rating changes and CEO turnover beyond firm performance. Using an adverse selection model that explicitly incorporates rating change related turnover, our model predicts that a downgrade triggers turnover, more so the lower the managerial entrenchment, but that this relation is weaker when the report provided by the rating agency is more reliable. Our empirical results support these predictions. We show that downgrades explain forced turnover risk, with the new CEO chosen outside the firm that has received the negative credit rating change. In addition, we find that the relation between rating changes and management turnover is stronger when the degree of managerial entrenchment is low, for firms characterized by a high level of investment and for firms less exposed to rating fees. Finally, we show that this relation has weakened in the post-2007 crisis period, in coincidence with the increased reputational concerns of rating agencies. The results are robust to endogeneity concerns.
“Credit Rating Agencies, Equity Analyst Recommendations and Information Flow to the Bond and Stock Markets”
with Thomas J. Chemmanur (Boston College, Carroll School of Management) and Igor Karagodsky (Boston College)
The study evaluates the discrepancies in the information content of equity analyst recommendations and ratings by issuer (S&P) and investor (Egan and Jones Rating Company – EJR) paid credit rating agencies. Specifically, we demonstrate that changes in leverage are associated with lower EJR ratings but higher equity analyst recommendations. Our results also suggest that signals by the investor-paid rating agency EJR are timelier than equity analyst recommendations or S&P ratings and seem to have the largest impact on firms’ investment levels. Finally, we find that EJR rating changes have larger impact on equity excess returns than S&P ratings and equity analyst recommendations particularly for firms with higher probability of default, while equity analyst recommendations have the highest impact on excess returns for non-risky firms.