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Tiebreaker: Certification and Multiple Credit Ratings

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  • DION BONGAERTS
  • K. J. MARTIJN CREMERS
  • WILLIAM N. GOETZMANN

Abstract

This paper explores the role played by multiple credit rating agencies (CRAs) in the market for corporate bonds. Moody’s, S&P and Fitch operate in a competitive setting with market demand for both credit information and the certification value of a high rating. We empirically document the outcome of this competitive interaction over the period 2002 to 2007. Virtually all bonds in our sample are rated by both Moody’s and Standard and Poors (S&P), and between 40% and 60% of the bonds are also rated by Fitch. This apparent redundancy in information production has long been a puzzle. We consider three explanations for why issuers apply for a third rating: ‘information production,’ ‘adverse selection’ and ‘certification’ with respect to regulatory and rules-based constraints. Using ratings and credit spread regressions, we find evidence in favor of Certification only. Additional evidence shows that the reported certification effects are consistent with an equilibrium outcome in a market with information-sensitive and insensitive bonds. In such a setting, ratings help to prevent market breakdowns.

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File URL: http://hdl.handle.net/10.1111/j.1540-6261.2011.01709.x
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Bibliographic Info

Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 67 (2012)
Issue (Month): 1 (02)
Pages: 113-152

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Handle: RePEc:bla:jfinan:v:67:y:2012:i:1:p:113-152

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  1. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
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Cited by:
  1. Becker, Bo & Milbourn, Todd, 2011. "How did increased competition affect credit ratings?," Journal of Financial Economics, Elsevier, vol. 101(3), pages 493-514, September.
  2. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2009. "The credit ratings game," Economics Working Papers 1149, Department of Economics and Business, Universitat Pompeu Fabra.
  3. Lawrence J. White, 2013. "Credit Rating Agencies: An Overview," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 93-122, November.
  4. Gwion Williams & Rasha Alsakka & Owain ap Gwilym, 2013. "The Impact of Sovereign Credit Signals on Bank Share Prices during the European Sovereign Debt Crisis," Working Papers 13007, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
  5. Dong Chen, 2014. "The Non-monotonic Effect of Board Independence on Credit Ratings," Journal of Financial Services Research, Springer, vol. 45(2), pages 145-171, April.
  6. Darren J. Kisgen & Philip E. Strahan, 2009. "Do Regulations Based on Credit Ratings Affect a Firm's Cost of Capital?," NBER Working Papers 14890, National Bureau of Economic Research, Inc.
  7. Grothe, Magdalena, 2013. "Market pricing of credit rating signals," Working Paper Series 1623, European Central Bank.
  8. Xia, Han, 2014. "Can investor-paid credit rating agencies improve the information quality of issuer-paid rating agencies?," Journal of Financial Economics, Elsevier, vol. 111(2), pages 450-468.

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