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Structural shifts in credit rating standards

Alp, Aysun (2012) Structural shifts in credit rating standards. (Accepted/In Press)

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Abstract

I examine the time series variation in corporate credit rating standards for the period 1985-2007. I report two main findings: (i) There is a divergent pattern between investment grade and speculative grade rating standards during 1985-2002. Investment grade ratings tighten between 1985 and 2002. In contrast, the speculative grade rating standards loosen during the same period. (ii) There is a sharp structural break in both investment grade and speculative grade standards towards more stringent ratings around 2002. The change in rating levels due to the structural break is both economically and statistically significant. Holding firm characteristics constant, firms experience a drop of 1.5 notches in ratings due to tightening standards between 2002 and 2007. The loosening in speculative grade ratings before 2002 is consistent with widespread criticism of the rating agencies during the Dot-Com crash and appears to be driven by revenue maximization concerns of rating agencies. On the other hand, the 2002 structural break is consistent with rating agencies responding to intense scrutiny. It appears that reputational concerns and threat of regulation led rating agencies to move towards more conservative ratings after the Enron debacle and passage of Sarbanes-Oxley Act.

Item Type:Article
Subjects:H Social Sciences > HG Finance
ID Code:19817
Deposited By:Aysun Alp
Deposited On:17 Oct 2012 12:50
Last Modified:17 Oct 2012 12:50

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