The Impact Of The Dodd-Frank Act On Credit Rating Agencies

Abstract

Over the last two decades and particularly during the financial crisis of 2008-09, credit rating agencies (CRAs) have faced an ongoing investor criticism over the quality of their ratings. In July 2010, U.S. Congress passed the Dodd-Frank Act (Dodd-Frank) which outlined a series of regulatory reforms to the credit rating industry. Specifically, Dodd-Frank removed the exemption of CRAs from Regulation Fair Disclosure (Reg FD), which allowed nonpublic information to be disclosed to CRAs, and eliminated all references to the role of credit ratings in regulatory requirements and capital adequacy ratios. This thesis examines the extent to which these changes have affected the informational content of ratings provided by Moody’s, S&P and in particular Fitch ratings. Firstly, this thesis investigates whether the removal of the informational advantage provided by the exemption from Reg FD impairs the quantity and quality of information available to CRAs and affects the consensus across Moody’s and S&P. As Fitch rating typically provides the third opinion after Moody’s and S&P, this thesis then tests whether the removal of ratings from regulatory requirements impacts the demand for Fitch ratings. Lastly, the informational content of Fitch ratings following Dodd-Frank is quantified by examining the market’s response to the publication of Fitch ratings in newly issued corporate bonds. The results confirm that the Dodd-Frank Act has had an impact, with Moody’s and S&P more likely to issue split ratings for newly issued corporate bonds following its passage. The results are robust to asset opaqueness proxies, market conditions, and different split rating measures. This thesis further shows that firms are less likely to seek a Fitch rating for newly issued bonds after the passage of Dodd-Frank, particularly firms assigned a split rating from Moody’s and S&P. Finally, this thesis shows that Fitch ratings are less informative following Dodd-Frank with a smaller market impact on credit spreads. Overall, the results suggest that Dodd-Frank has an adverse effect on the consensus across CRAs and diminishes the role that Fitch plays in the corporate bond market.