Three Essays on Credit Ratings

Abstract

This thesis consists of three standalone studies on credit ratings. The first study is about split credit ratings. The introduction of the Dodd-Frank Act in 2010 reduced the importance of credit ratings and increased the penalties on credit rating agencies (CRAs) for inaccurate ratings. This study shows that the proportion of split-rated bonds increases after Dodd-Frank was enacted. These results are consistent with the threat of litigation making credit analysts engage in idiosyncratic information discovery to produce defendable quantitative information, thus leading to more split ratings. The second study examines the change in the regulatory use of multiple credit ratings after Dodd-Frank. This study finds that post Dodd-Frank reform, firms are less likely to demand a third rating (typically from Fitch) for ratings near the HY-IG boundary to support their new corporate bond issues. Third ratings also become less informative post Dodd-Frank, with a much weaker market impact on credit spreads for firms with S&P and Moody’s ratings on opposite sides of the HY-IG boundary. This study provides new evidence on the effect of Dodd-Frank in curbing corporate borrowers’ strategic use of multiple credit ratings near this boundary. The third study examines the effect of credit rating disagreements on merger and acquisition (M&A) decisions. It shows that acquirers with split ratings prefer to use stock to finance their acquisitions. More importantly, this study finds that acquirers with split ratings experience lower announcement returns. Further analysis shows that overpayment by acquirers with split ratings is concentrated in acquirers with entrenched managers. Overall, the evidence indicates that credit rating disagreements are heavily priced in the M&A market. Overall, this thesis provides new empirical evidence on the financial market implications of discordance in credit assessments across CRAs and how it shapes firms’ financial decisions.