Essays on Determinants and Effects of Credit Ratings

Abstract

My dissertation is comprised of two independent essays related to credit ratings. Credit ratings have substantially impacted the financial market. However, following several accounting scandals and the financial crisis, the quality of credit ratings has been criticized. In this respect, I examine determinants and effects of credit ratings. Below, I briefly explain the two essays in my dissertation. In my first essay, I examine the time-series change in the explanatory power of accounting information for credit ratings (defined as rating relevance) from 1985 to 2014. I find a significantly increasing trend of rating relevance of accounting information. Capital information primarily drives this increasing trend compared to performance information. Moreover, rating relevance has increased after the passage of the Dodd-Frank Act and is positively associated with the entry of newly listed firms in the credit rating market. The results indicate that credit rating agencies have relied more on publicly available accounting information than on privately collected information in assessing credit ratings over time. The pattern can be explained by increased legal and reputational liability of credit rating agencies. My second essay examines rating optimism of Korean companies and consequences of rating optimism on Korean economy. I construct a proxy for optimism in Korean firms credit ratings as deviations of actual credit ratings from the benchmark ratings estimated with U.S. credit ratings. I show average credit ratings of Korean firms in 2014 experience a three-notch drop if such firms are rated by global credit rating agencies. Next, I find that such rating optimism is negatively associated with firms interest expenses and bond spread and positively related to firms debt issuance and investment. In addition, such increased investment is more (less) likely to be classified as over-(under-) investment and long-term performance from such investment tends to be poor. The results indicate that Korean debt investors have difficulty in appreciating the rating optimism of Korean firms, enabling the firms to borrow debt at a low interest rate and to inefficiently increase their investment. Further, the rating optimism affects the survivorship bias in the Korean debt market and can be partially explained by the effect of business groups.