Reputational shocks and the information content of credit ratings

We investigate how shocks to the reputation of credit rating agencies and the subsequent introduction of stricter regulation affect investors’ reaction to rating signals. We focus on three major episodes of reputational distress: the Enron/WorldCom scandals, the subprime crisis and the lawsuit again...

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Bibliographic Details
Published inJournal of financial stability Vol. 34; pp. 44 - 60
Main Authors Bedendo, Mascia, Cathcart, Lara, El-Jahel, Lina
Format Journal Article
LanguageEnglish
Published Elsevier B.V 01.02.2018
Elsevier
Subjects
Credit rating agencies
Economics and Finance
Humanities and Social Sciences
Rating announcements
Regulation
Reputational shocks
Rating announcements
G24
Reputational shocks
Regulation
G14
G28
Credit rating agencies
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Summary:We investigate how shocks to the reputation of credit rating agencies and the subsequent introduction of stricter regulation affect investors’ reaction to rating signals. We focus on three major episodes of reputational distress: the Enron/WorldCom scandals, the subprime crisis and the lawsuit against Standard & Poor's. We document a stronger response of stock investors to downgrades in the aftermath of reputational shocks, which is not, however, accompanied by an improvement in rating quality. Our results are consistent with a scenario where, following evidence of misrating, market investors conclude that ratings are generally overstated and infer greater negative information from downgrades. The effect is stronger for the investment-grade segment, where rating errors have a wider reputational impact. The introduction of new regulatory measures such the SOX Act, the CRA Reform Act and the Dodd-Frank Act, seems instead to improve rating quality and soften investors’ response.
ISSN:1572-3089
1878-0962
DOI:10.1016/j.jfs.2017.12.003