The Economic Consequences of Corporate Credit Rating Errors

dc.contributor.author Naughton, James
dc.contributor.author Basu, Riddha
dc.date.accessioned 2019-12-06T18:38:07Z
dc.date.available 2019-12-06T18:38:07Z
dc.date.issued 2019-08-30
dc.description.abstract 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.
dc.identifier.uri http://hdl.handle.net/10125/64894
dc.subject Corporate credit ratings
dc.subject off-balance-sheet finance
dc.subject pension accounting
dc.subject SFAS158
dc.title The Economic Consequences of Corporate Credit Rating Errors
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