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Are Credit Ratings More Rigorous for Widely Covered Firms?

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Abstract

We study how business press coverage can discipline credit rating agency actions. Because of their greater prominence and visibility to market participants, more widely covered firms can pose greater reputational costs for rating agencies. Consistent with rating agencies limiting such risk, we find that ratings for more widely covered firms are more timely and accurate, downgraded earlier and systematically lower in the year prior to default, and better predictors of default and non-default. We also find that the recent tightening of credit rating standards is largely explained by growing business press coverage of public debt issuers. Additionally, we find that credit rating agencies take explicit actions to improve their ratings by assigning better educated and more experienced analysts to widely covered firms. Moreover, we document that missed defaults of more visible firms create greater negative economic consequences for rating agencies, and that rating improvements following the financial crisis were greater for more visible firms. Data Availability: All data are publicly available from the sources identified in the text.

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... 12 With credit ratings, our model can be further reinterpreted. Bonsall et al. (2018) and Kraft (2015) provide evidence of credit rating agencies basing their ratings on financial information provided in annual reports (i.e., r) and subjective adjustments based on additional information instance, market cap. 13 Fifth, banks face prospects ranging from depositor runs to FDIC receivership if depositors', creditors', or regulators' beliefs about the bank's future prospects fall below a threshold (e.g., Gao and Jiang 2018). ...
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... Dimitrov, Palia, and Tang (2015) and deHaan (2017) both find that after the 2008 financial crisis, rating agencies responded to public criticism and regulatory pressures to protect their reputations. Bonsall et al. (2018) find that credit ratings of firms with more press coverage are timelier and more accurate. Baker, Dutta, Saadi, and Zhong (2019) show that media coverage influences the changes in credit ratings, and negative press coverage has a stronger relation with credit rating change events. ...
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This study investigates the impact of dissemination on the efficiency of the price discovery process with respect to management earnings guidance disclosures. I first identify firm and guidance characteristics associated with the likelihood that guidance receives coverage in the Dow Jones Newswires. Using propensity score, within-firm, and returns-based matched control samples of guidance, I find that newswire dissemination is associated with larger initial price reactions and, more importantly, an increase in the speed with which guidance information is incorporated into price. I also find that newswire coverage affects the market's reaction to stand-alone versus bundled guidance and good versus bad news guidance. This study is the first to provide evidence of systematic variation, both across and within firms, in the breadth of guidance dissemination, and it shows that this variation has a substantial effect on how investors respond to guidance. JEL Classifications: G14; M41; L82.
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We analyze the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on corporate bond ratings issued by credit rating agencies (CRAs). We find no evidence that Dodd-Frank disciplines CRAs to provide more accurate and informative credit ratings. Instead, following Dodd-Frank, CRAs issue lower ratings, give more false warnings, and issue downgrades that are less informative. These results are consistent with the reputation model of Morris (2001), and suggest that CRAs become more protective of their reputation following the passage of Dodd-Frank. Consistent with Morris (2001), we find that our results are stronger for industries with low Fitch market share, where Moody's and Standard & Poor's have stronger incentives to protect their reputation (Becker and Milbourn, 2011). Our results are not driven by business cycle effects or firm characteristics, and strengthen as the uncertainty regarding the passage of Dodd-Frank gets resolved. We conclude that increasing the legal and regulatory costs to CRAs might have an adverse effect on the quality of credit ratings.
Article
I investigate variation in how well firm-initiated disclosures are transmitted to investors. Improved dissemination is hypothesized to lower the cost of information acquisition and increase firm visibility. Through instrumentation, I examine the impact of differential dissemination of firm-initiated disclosures by the press on bid-ask spreads, trading volume, and idiosyncratic volatility. I find that improved transmission causally lowers bid-ask spreads, increases trading volume, and lowers idiosyncratic volatility. Ultimately, the results suggest that the economic impact of a firm's disclosure program is affected by both the level of disclosure and the effectiveness of mechanisms in distributing firm-initiated information to investors.
Article
We investigate a prominent allegation in congressional hearings that Moody's loosened its rating standards to chase revenue after it went public in 2000. Consistent with this allegation, Moody's ratings for both corporate bonds and structured finance products are significantly more favorable to issuers, relative to S&P's, after Moody's IPO. Moreover, Moody's ratings are more favorable for clients subject to greater conflict of interest. There is little evidence that Moody's higher ratings, post-IPO, are more informative, measured as expected default frequencies (EDFs) or as the probability of default. Our findings inform the debate on whether financial gatekeepers should be publicly traded.
Article
This article examines the consequences of “around-the-clock” news cycles online for the product of news. It argues that as a result of increased emphasis on continuous deadlines, the “news story” is diversified into a fluid, always updated/corrected product challenging existing notions of news as a set piece of work. In this context, “time” becomes an even more important factor for news production and blurs further pre-existing news formats. The “continuously updated news story” can change many times during the day and challenges the idea of news as the finished product of journalistic work. This research studies six UK news websites and monitors how specific news stories are broken and updated during the course of a day. It specifically focuses on the frequency of updates, the amount and type of information added as well as their sources in order to investigate patterns of news updating in each organisation. The patterns of news updating that emerge suggest that we need to rethink the “news story” as a fixed entity which has been associated with the distinct news cycles of traditional media. Although the daily cycles are not completely abolished, the news stories are rarely finalised.
Article
This article explores the growth and character of breaking news on two 24-hour news channels in the United Kingdom, Sky News and BBC News 24. Our purpose is to examine, in detail, the nature and role of breaking news and, more generally, its impact on the quality of television news journalism. We draw upon a series of content analyses of news programming conducted in 2004, 2005/6 and 2007, and compare the elements of a breaking news item with more conventional forms of news. Our findings indicate that “breaking news” has become an increasingly important part of the 24-hour news culture. This growth means that the typical breaking news item is becoming increasingly predictable and routine. Moreover, by most measures, breaking news items are less well informed and feature less independent reporting than conventional news items. As a consequence, we argue, the decision to cover more breaking news stories impoverishes the quality of journalism.
Article
Combining a database of short sellers' trading patterns with a database of news releases, we show that short sellers' trading advantage comes largely from their ability to analyze publicly available information. Specifically, the prior finding that short sellers' trades predict future negative returns (e.g., Boehmer, Jones, and Zhang (2008) and Asquith, Pathak, and Ritter (2005)) is more than twice as strong in the presence of news stories. Further, the most profitable short sales do not appear to come from market makers, but from clients, and these client short sales are particularly profitable in the presence of news. We find no evidence that short sellers anticipate news events, as the ratio of short sales to total volume is nearly constant around news periods, and when we do find differences between the timing of short sellers' trades and the overall market, relative to other types of trading there is a significant increase in short selling after news stories. We also find no evidence to support the idea the short selling around news events is more profitable because of liquidity effects; in fact, we find an increase in transaction costs on news days. Finally, short sellers' ability to predict returns appears to be concentrated in many of the news categories in which short sellers trade relatively late, a finding consistent with the idea that short sellers' advantage arises from their ability to process publicly available information.
Article
I examine how media coverage of a company"s good and bad news affects the stock price response, by looking at the effect of investor relations (IR) firms. I find that IR firms "spin" their clients" news by generating more media coverage of positive press releases than negative press releases. This spin increases announcement returns. Around earnings announcements however, IR firms cannot spin the news, and IR firm clients" returns are significantly lower. This is consistent with positive media coverage increasing investor expectations, creating disappointment around hard earnings information. Using reporter connections and geographical links to newspapers, I argue that IR firms are causally affecting both media coverage and returns.
Article
The collapse of AAA-rated structured finance products in 2007 to 2008 has brought renewed attention to conflicts of interest in credit rating agencies (CRAs). We model competition among CRAs with three sources of conflicts: (1) CRAs conflict of understating risk to attract business, (2) issuers’ ability to purchase only the most favorable ratings, and (3) the trusting nature of some investor clienteles. These conflicts create two distortions. First, competition can reduce efficiency, as it facilitates ratings shopping. Second, ratings are more likely to be inflated during booms and when investors are more trusting. We also discuss efficiency-enhancing regulatory interventions.
Article
Disentangling the causal impact of media reporting from the impact of the events being reported is challenging. We solve this problem by comparing the behaviors of investors with access to different media coverage of the same information event. We use zip codes to identify 19 mutually exclusive trading regions corresponding with large U.S. cities. For all earnings announcements of S&P 500 Index firms, we find that local media coverage strongly predicts local trading, after controlling for earnings, investor, and newspaper characteristics. Moreover, local trading is strongly related to the timing of local reporting, a particular challenge to nonmedia explanations.
Article
Credit rating agencies (CRAs) are accused of bearing a strong responsibility for contributing to the subprime crisis by having been deliberately too lax in the ratings of some structured products. In response to this accusation, CRAs argue that such an attitude would be too dangerous for them, since their reputation is at stake. The objective of this article is to examine the validity of this argument within a formal model: Are reputation concerns sufficient to discipline rating agencies? We show that the reputation argument only works when a sufficiency large fraction of the CRA income comes from other sources than rating complex products. By contrast when rating complex products becomes a major source of income for the CRA, we show that it is always too lax with a positive probability and inflates ratings with probability one when its reputation is good enough. We provide some empirical support for this prediction, by showing that ceteris paribus, the proportion of subprime residential mortgage-backed securities (RMBS) that were rated AAA by the three main CRAs indeed increased over the last eight years. We analyze the policy implications of our findings and advocate for a new business model of CRAs that we call the platform-pays model.
Article
In this paper, we review research into the economic consequences of voluntary and mandatory choices of accounting techniques and standards. We discuss how the predictions of extant economic consequence theories are driven by contracting and monitoring costs associated with management compensation contracts, bond covenants, regulation, and/or political visibility. We review empirical tests of economic consequence theories, categorize those tests, and discuss their strengths and weaknesses. The empirical tests reveal two systematic associations with accounting choice: size, a proxy for political visibility, and leverage, a proxy for contracting and monitoring costs of lending agreements. Interpretation of the results is difficult, due to general limitations of the tests. We conclude by suggesting some directions for future research, based on our analysis of the potential payoffs associated with different types of empirical tests.
Article
We examine the press’ role in monitoring and influencing executive compensation practice using more than 11,000 press articles about CEO compensation from 1994 to 2002. Negative press coverage is more strongly related to excess annual pay than to raw annual pay, suggesting a sophisticated approach by the media in selecting CEOs to cover. However, negative coverage is also greater for CEOs with more option exercises, suggesting the press engages in some degree of “sensationalism.” We find little evidence that firms respond to negative press coverage by decreasing excess CEO compensation or increasing CEO turnover.
Article
This paper provides evidence on whether managers can reduce stockholder litigation costs by disclosing adverse earnings news ‘early’. Inconsistent with this idea, I find that voluntary disclosures occur more frequently in quarters that result in litigation than in quarters that do not. However, this result occurs because managers' incentives to predisclose earnings news increase as the news becomes more adverse, presumably because this reduces the cost of resolving litigation that inevitably follows in bad news quarters. After controlling for these incentives using estimated stockholder damages, I find some evidence that more timely disclosure is associated with lower settlement amounts.
Article
The conditions under which transactors can use the market (repeat-purchase) mechanism of contract enforcement are examined. Increased price is shown to be a means of assuring contractual performance. A necessary and sufficient condition for performance is the existence of price sufficiently above salvageable production costs so that the nonperforming firm loses a discounted steam of rents on future sales which is greater than the wealth increase from nonperformance. This will generally imply a market price greater than the perfectly competitive price and rationalize investments in firm-specific assets. Advertising investments thereby become a positive indicator of likely performance.
Article
This paper derives an equilibrium price-quality schedule for markets in which buyers cannot observe product quality prior to purchase. In such markets there is an incentive for sellers to reduce quality and take short-run gains before buyers catch on. In order to forestall such quality cutting, the price-quality schedule involves high quality items selling at a premium above their cost. This premium also serves the function of compensating sellers for their investment in reputation. The effects of improved consumer information and of a minimum quality standard on the equilibrium price-quality schedule are studied. In general, optimal quality standards exclude from the market items some consumers would like to buy.
Article
This paper empirically examines whether major domestic oil companies held down product prices relative to their less visible counterparts during the 1979 oil crisis. We compare company prices on unregulated fuel oil with a measure of political pressure—the level of television coverage of the energy crisis. We find that media coverage influenced home heating oil price ratios, but did not influence residual fuel oil price ratios for the same companies. We argue that this differential pricing pattern is rational in a politically sensitive period.
Article
In recent years, credit rating agencies have faced increased regulatory pressure and investor criticism for their ratings' lack of timeliness. This study investigates whether and how rating agencies respond to such pressure and criticism. We find that the rating agencies not only improve rating timeliness, but also increase rating accuracy and reduce rating volatility. Our findings support the criticism that, in the past, rating agencies did not avail themselves of the best rating methodologies/efforts possible. When their market power is threatened by the possibility of increased regulatory intervention and/or reputation concerns, rating agencies respond by improving their credit analysis.
Article
ABSTRACT In this study, we examine whether managers delay disclosure of bad news relative to good news. If managers accumulate and withhold bad news up to a certain threshold, but leak and immediately reveal good news to investors, then we expect the magnitude of the negative stock price reaction to bad news disclosures to be greater than the magnitude of the positive stock price reaction to good news disclosures. We present evidence consistent with this prediction. Our analysis suggests that management, "on average", delays the release of bad news to investors. Copyright (c), University of Chicago on behalf of the Institute of Professional Accounting, 2008.
Article
In recent years, the number of downgrades in corporate bond ratings has exceeded the number of upgrades, leading some to conclude that the credit quality of U.S. corporate debt has declined. However, an alternative explanation of this apparent decline in credit quality is that the rating agencies are now using more stringent standards in assigning ratings. An ordered probit analysis of a panel of firms from 1978 through 1995 suggests that rating standards have indeed become more stringent, implying that at least part of the downward trend in ratings is the result of changing standards. Copyright The American Finance Association 1998.
Article
We use panel data on prices and net asset values to test whether dramatic country-specific news affects the response of closed-end country fund prices to asset value. In a typical week, prices underreact to changes in fundamentals; the (short-run) elasticity of price with respect to asset value is significantly less than one. In weeks with news appearing on the front page of "The New York Times", prices react much more; the elasticity of price with respect to asset value is closer to one. These results are consistent with the hypothesis that news events lead some investors to react more quickly. Copyright The American Finance Association 1998.
Article
The authors model reputation acquisition by investment banks in the equity market. Entrepreneurs sell shares in an asymmetrically informed equity market either directly or using an investment bank. Investment banks, who interact repeatedly with the equity market, evaluate entrepreneurs' projects and report to investors in return for a fee. Setting strict evaluation standards (unobservable to investors) is costly for investment banks, inducing moral hazard. Investment banks' credibility, therefore, depends on their equity-marketing history. Investment banks' evaluation standards, their reputations, underwriter compensation, the market value of equity sold, and entrepreneurs' choice between underwritten and nonunderwritten equity issues emerge endogenously. Copyright 1994 by American Finance Association.
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Do credit rating agencies threaten our financial stability?
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Are the ratings agencies credit worthy?
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crisis still hangs over credit-rating firms
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What caused the financial crisis?
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