Abstract Using Regulation SHO as a controlled experiment, we examine the impact of short‐selling threats on credit rating performance and credit rating usage in debt contracts. We find that when ...short‐selling constraints are removed for pilot firms, rating accuracy increases, but rating stability decreases for these firms relative to non‐pilot firms. This result suggests that short‐selling threats push rating agencies to enhance rating accuracy at the cost of rating stability. We also find less rating usage in debt contracts for pilot firms than for non‐pilot firms when short‐selling constraints are removed for pilot firms, suggesting that in the presence of short‐selling threats, debt contracting parties emphasize rating stability over rating accuracy. Overall, our study informs academics, practitioners and regulators about short sellers’ disciplining effect on rating agencies and provides novel evidence on the rating property trade‐off and its implication for rating usage.
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BFBNIB, FZAB, GIS, IJS, KILJ, NLZOH, NUK, OILJ, SAZU, SBCE, SBMB, UL, UM, UPUK
The credit rating industry has historically been dominated by just two agencies, Moody's and Standard & Poor's, leading to long-standing legislative and regulatory calls for increased competition. ...The material entry of a third rating agency (Fitch) to the competitive landscape offers a unique experiment to empirically examine how increased competition affects the credit ratings market. What we find is relatively troubling. Specifically, we discover that increased competition from Fitch coincides with lower quality ratings from the incumbents: Rating levels went up, the correlation between ratings and market-implied yields fell, and the ability of ratings to predict default deteriorated. We offer several possible explanations for these findings that are linked to existing theories.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UL, UM, UPCLJ, UPUK
Credit rating agencies (CRAs) have long held that reputational concerns discipline their behavior. The value of reputation, however, depends on economic fundamentals that vary over the business ...cycle. In a model of ratings incorporating endogenous reputation and a market environment that varies, we find that ratings quality is countercyclical. Specifically, a CRA is more likely to issue less-accurate ratings when fee-income is high, competition in the labor market for analysts is tough, and securities' default probabilities are low. Persistence in economic conditions can diminish our results, while mean reversion exacerbates them. The presence of naive investors reduces overall quality, but quality remains countercyclical. Finally, we demonstrate that competition among CRAs yields similar results.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UL, UM, UPCLJ, UPUK
In this study, we examine the predictive performance of a wide class of binary classifiers using a large sample of international credit ratings changes from the period 1983–2013. Using a number of ...financial, market, corporate governance, macro-economic and other indicators as explanatory variables, we compare classifiers ranging from conventional techniques (such as logit/probit and LDA) to fully nonlinear classifiers, including neural networks, support vector machines and more recent statistical learning techniques such as generalised boosting, AdaBoost and random forests. We find that the newer classifiers significantly outperform all other classifiers on both the cross sectional and longitudinal test samples; and prove remarkably robust to different data structures and assumptions. Simple linear classifiers such as logit/probit and LDA are found nonetheless to predict quite accurately on the test samples, in some cases performing comparably well to more flexible model structures. We conclude that simpler classifiers can be viable alternatives to more sophisticated approaches, particularly if interpretability is an important objective of the modelling exercise. We also suggest effective ways to enhance the predictive performance of many of the binary classifiers examined in this study.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UL, UM, UPCLJ, UPUK
Credit rating agencies do not only disclose simple ratings but announce watchlists (rating reviews) and outlooks as well. This paper analyzes the economic function underlying the review procedure. ...Using Moody’s rating data between 1982 and 2004, we find that for borrowers of high creditworthiness, rating agencies employ watchlists primarily in order to improve the delivery of information. For low-quality borrowers, in contrast, the review procedure seems to have developed into an implicit contract á la
Boot et al. (2006), inducing the companies “on watch” to abstain from risk-augmenting actions. The agencies’ economic role hence appears to have been enhanced from a pure information certification towards an active monitoring function.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UL, UM, UPCLJ, UPUK
Taking as its focus the not-so-special case of Detroit, which recently experienced the largest municipal bankruptcy in US history, this article explores the financialization of American urban ...governance in both conceptual and concrete terms. The financially mediated restructuring of Detroit, through the imposition of emergency management by the state of Michigan and subsequently through the federal bankruptcy code, has been portrayed as an extreme event, with deep roots in histories of deindustrialization, racial exclusion, and suburban flight. It is not to downplay the significance of this experience to suggest, however, that the Detroit case also represents an ordinary crisis of a faltering regime of financialized urbanism. Compounding a shift toward entrepreneurial urban governance, cities now find themselves in an operating environment that has been constitutively financialized. Bondholder-value disciplines have become systemic in reach, along with an amplified role for financial gatekeepers like credit rating agencies; technocratic forms of financial management have been spreading and deepening, both in supposedly normal times and under externally imposed emergency measures; and in some cities the routinized play of growth-machine politics is being eclipsed by a new generation of debt-machine dynamics. While the ultimate focus of this article is on Detroit, its chief concern is with the framing of the city's storied financial crisis-theoretically and then institutionally.
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BFBNIB, DOBA, INZLJ, IZUM, KILJ, NMLJ, NUK, PILJ, PNG, SAZU, SIK, UILJ, UKNU, UL, UM, UPUK, ZRSKP
This study revisits the existing evidence of a downward trend in credit rating standards indicating that Credit Rating Agencies (CRAs) have become more conservative over time. We find that the ...time-series variation in the proxy for rating standards is mostly driven by the market-based variables in the model, specifically market capitalization and idiosyncratic volatility. We examine an alternative specification of the model, incorporating risk characteristics of rated firms relative to those of the average firm in the economy, and find it to have a higher explanatory power. Most importantly, we find little evidence of increased conservatism over time, in contrast to prior studies.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NLZOH, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UILJ, UL, UM, UPCLJ, UPUK, ZAGLJ, ZRSKP
Factoring is a financial arrangement where the supplier sells accounts receivable to the factor against a premium and receives cash for immediate working capital needs. Reverse factoring takes ...advantage of the retailer’s payment guarantee and the credit rating differential between a small supplier and a large retailer, enabling the supplier to receive financing at a more favorable rate. We develop a supply chain theory of (recourse/non-recourse) factoring and reverse factoring showing when these post-shipment financing schemes should be adopted and who really benefits from the adoption. We find that recourse factoring is preferred when the supplier’s credit rating is relatively high, whereas non-recourse factoring is preferred within certain medium range of ratings. Both factoring schemes, if adopted, benefit both the supplier and the retailer, and thus the overall supply chain. Further, we find that reverse factoring may not always be preferred by suppliers compared to recourse and non-recourse factorings. Retailers should only offer reverse factoring to suppliers with low (but above a threshold) to medium credit ratings. The optimally designed reverse factoring program can always increase the retailer’s profit, but it may leave the supplier indifferent to the current factoring option when followed by an aggressive payment extension. More importantly, contrary to conventional wisdom, our theory implies that reverse factoring could be adopted even when the retailer has no credit rating advantage over the supplier, and it could benefit the retailer even without extending payment terms.
This paper was accepted by Victor Martínez-de-Albéniz, operations management.
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.
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GEOZS, IJS, IMTLJ, KILJ, KISLJ, NUK, OILJ, PNG, SAZU, SBCE, SBJE, UL, UM, UPCLJ, UPUK
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