05 Financial: Debt Market Research (Including Credit Ratings/Debt Contracts)
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ItemRegulatory Reform, Multiple Credit Ratings and the Quality of the Corporate Information Environment( 2019-08-31)This paper examines the change in the regulatory use of multiple credit ratings after the Dodd-Frank Act (Dodd-Frank). We find that post Dodd-Frank reform firms are less likely to demand a third rating, which is typically provided by Fitch. Third ratings also become less informative with a much weaker market impact on credit spreads for firms on opposite sides of the high yield (HY) - investment grade (IG) boundary. Moreover, we find that post-Dodd-Frank, firms without external monitoring from a third ratings agency systematically manage their earnings more and have higher cash flow and sales volatilities. Overall, the results shed light on the unintended consequences of Dodd-Frank on competition within the ratings industry, the quality of the information environment, and the cost of borrowing for issuers.
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ItemDo banks influence stock crash risk? Evidence from banking deregulation( 2019-08-31)An extensive literature shows that managers’ withholding of bad news, an agency problem in corporate governance, plausibly causes stock price crashes. This literature, however, has not examined whether and how lending banks influence borrowing firms’ crash risk, despite banks’ advantageous role in corporate governance via their monitoring and funding functions. We fill this void in this study. To mitigate endogeneity, we exploit the staggered reforms in U.S. state-level banking markets that gradually lift barriers for interstate branching. These deregulation events, which are exogenous to firms, represent historically important shocks to bank competition, and bank competition can fundamentally alter bank monitoring and funding behaviors. We find robust evidence that bank competition reduces firm crash risk, and the effect is stronger in scenarios in which bank monitoring and funding are likely to exert greater influences. Bank competition also mitigates abrupt divulgence of adverse information, suppresses earnings management, and improves reporting quality, which helps explain the decline in crash risk.
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ItemThe Economic Consequences of Corporate Credit Rating Errors( 2019-08-30)We show that errors by credit rating agencies can have significant real effects on rated firms. Specifically, we find that firms increase investment and adjust their capital structure following an exogenous correction to the credit rating adjustment process that occurred through the implementation of Financial Accounting Standards Board Statement No. 158 (“SFAS158”). Prior to SFAS158, Moody’s and S&P did not correctly account for the presence of minimum liability adjustments for off-balance sheet pension obligations. Since neither firms nor the rating agencies were aware of this error, SFAS158 exogenously corrected the errors in the rating agency adjustments, thus allowing us to identify the effect of changes in credit rating labels independent of changes in firm fundamentals. We show that firms with higher minimum liability adjustments pre-SFAS158 are more likely to experience an improvement in credit rating post-SFAS158 relative to low minimum liability adjustment firms even though there is no detectable change in the credit quality of these firms relative to low minimum liability adjustment firms. In addition, firms with larger minimum liability adjustments are more likely to increase capital investment and shift capital structure toward debt financing post-SFAS158 relative to low minimum liability adjustment firms. Overall, our results indicate that credit rating errors have real economic consequences for rated firms because credit rating labels drive economic choices that are independent of firm fundamentals.
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ItemWalking the Walk: CSR Disclosures and Bank Practices( 2019-08-30)Socially responsible banks portray themselves as community pillars, particularly for low-to-middle income neighborhoods. We examine the truthfulness of this portrayal by studying the implications of banks’ corporate social responsibility (CSR) disclosures for their product pricing and lending behavior. Using an instrumental variable approach that addresses selection bias, we find that high-CSR banks offer lower deposit rates, charge higher loan rates, and limit capital supply in poorer neighborhoods relative to their low-CSR peers. We also find high CSR banks attract more mortgage loan applications from females and disadvantaged minority groups. Collectively, our findings suggest that banks capitalize on CSR disclosures, obtaining product differentiation and pricing power.
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ItemManagerial Risk Tolerance and Corporate Credit Ratings( 2019-08-29)This study examines whether and how managerial risk tolerance influences corporate credit ratings. Using the possession of a private pilot license to capture CEO risk tolerance, we find that firms led by pilot CEOs have worse credit ratings after controlling for firm fundamentals, CEO risk-taking incentives, and other CEO characteristics. Path analyses show that risk-tolerant CEOs lead to worse credit ratings by reducing the level of future firm value, increasing the volatility of future firm value, and changing rating agencies’ assessment of management. Also, the negative association between CEO risk tolerance and credit ratings is more pronounced when management play a more important role in a firm. Overall, our study sheds light on the dark side of managerial risk tolerance by documenting its adverse impact on corporate credit ratings.
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ItemShort Sellers and Credit Rating Quality: Evidence from a Natural Experiment( 2019-08-26)Using Regulation SHO as a controlled experiment, we examine the effect of short sellers on credit rating quality. We find a larger improvement in rating quality for pilot firms than for non-pilot firms when short sale constraints are removed for pilot firms. Further analyses document two mechanisms through which short sellers increase rating quality: short sellers discipline rating agencies by threatening to expose rating inaccuracies and provide additional information to rating agencies. Overall, this study highlights an important market force’s (i.e., short sellers’) effect on rating quality. The findings should be informative to academics and regulators who remain interested in improving rating quality.
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ItemForeign cash holdings and credit rating: Evidence from U.S. multinationals( 2019-08-07)Using a sample of listed U.S. multinationals in 1999-2016, we document a positive correlation between foreign cash holdings and credit ratings, suggesting that firms may credibly signal their liquidity by accumulating large foreign cash reserves and pledging not to repatriate “in the foreseeable future”. Also, we find that this positive correlation is stronger in financially distressed firms, suggesting that the escalated signaling costs (e.g., an increased penalty in the case of cash shortages) in financially distressed firms amplify the signaling effect of foreign cash holdings, and thus, strengthen its positive impact on credit rating assessments. These two findings hold for an instrumental variable approach, reducing the likelihood of our results being purely driven by endogeneity bias. In additional analyses, we find that rating agencies are more conservative in discounting the value of foreign cash holdings when multinational firms are at the investment-grade cutoff and/or are subject to higher repatriation costs.