The Economic Function of Credit Rating Agency and Watchlist

Abstract

Despite increasing importance, the economic function of watchlist of Korean credit rating agency (CRA) has not been studied profoundly yet. Two explanatory lines exist for the reason behind watchlist placement: information delivery vs. implicit contract. Information delivery argument suggests that CRAs place watchlist to meet investors demand for accurate and stable rating information. Implicit contract argument suggests that CRAs place watchlist to give a firm chance to recover from deteriorated credit quality. I find that watchlist placement is more strongly associated with the information delivery argument. Albeit not strong, evidence also indicates that CRAs do consider fundamental quality of a firm and that accounting quality matters in watchlist placement process. Overall, findings suggest that a CRA in Korea has enhanced its economic role as an information intermediary using watchlist.