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The Economics of Rating Watchlists: Evidence from Rating Changes

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Author Info
Christina E. Bannier ()
Christian Hirsch ()

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Abstract

Generally, information provision and certification have been identified as the major economic functions of rating agencies. This paper analyzes whether the “watchlist” (rating review) Instrument has extended the agencies’ role towards a monitoring position, as proposed by Boot, Milbourn, and Schmeits (2006). Using a data set of Moody’s ratings between 1982 and 2004, we find that the overall information content of rating action has indeed increased due to the introduction of the watchlist procedure. Our findings suggest that rating reviews help to establish implicit monitoring contracts between agencies and borrowers and as such enable a finer partition of rating information, thereby contributing to a higher information quality.

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Paper provided by Department of Finance, Goethe University Frankfurt am Main in its series Working Paper Series: Finance and Accounting with number 184.

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Date of creation: Feb 2008
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Handle: RePEc:fra:franaf:184

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Find related papers by JEL classification:
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
G29 - Financial Economics - - Financial Institutions and Services - - - Other
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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  1. Michael P. Murray, 2006. "Avoiding Invalid Instruments and Coping with Weak Instruments," Journal of Economic Perspectives, American Economic Association, vol. 20(4), pages 111-132, Fall.
  2. Jorion, Philippe & Liu, Zhu & Shi, Charles, 2005. "Informational effects of regulation FD: evidence from rating agencies," Journal of Financial Economics, Elsevier, vol. 76(2), pages 309-330, May. [Downloadable!] (restricted)
  3. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. " The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-52, June. [Downloadable!] (restricted)
  4. Boehmer, Ekkehart & Masumeci, Jim & Poulsen, Annette B., 1991. "Event-study methodology under conditions of event-induced variance," Journal of Financial Economics, Elsevier, vol. 30(2), pages 253-272, December. [Downloadable!] (restricted)
  5. Michael Faulkender & Mitchell A. Petersen, 2006. "Does the Source of Capital Affect Capital Structure?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 19(1), pages 45-79. [Downloadable!] (restricted)
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  6. Loffler, Gunter, 2005. "Avoiding the rating bounce: why rating agencies are slow to react to new information," Journal of Economic Behavior & Organization, Elsevier, vol. 56(3), pages 365-381, March. [Downloadable!] (restricted)
  7. Holthausen, Robert W. & Leftwich, Richard W., 1986. "The effect of bond rating changes on common stock prices," Journal of Financial Economics, Elsevier, vol. 17(1), pages 57-89, September. [Downloadable!] (restricted)
  8. Loffler, Gunter, 2004. "Ratings versus market-based measures of default risk in portfolio governance," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2715-2746, November. [Downloadable!] (restricted)
  9. Flannery, Mark J. & Rangan, Kasturi P., 2006. "Partial adjustment toward target capital structures," Journal of Financial Economics, Elsevier, vol. 79(3), pages 469-506, March. [Downloadable!] (restricted)
  10. Goh, Jeremy C. & Ederington, Louis H., 1999. "Cross-sectional variation in the stock market reaction to bond rating changes," The Quarterly Review of Economics and Finance, Elsevier, vol. 39(1), pages 101-112. [Downloadable!] (restricted)
  11. A. Craig MacKinlay, 1997. "Event Studies in Economics and Finance," Journal of Economic Literature, American Economic Association, vol. 35(1), pages 13-39, March. [Downloadable!] (restricted)
  12. Peter MacKay & Gordon M. Phillips, 2005. "How Does Industry Affect Firm Financial Structure?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 18(4), pages 1433-1466. [Downloadable!] (restricted)
  13. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November. [Downloadable!] (restricted)
  14. Arnoud W. A. Boot & Todd T. Milbourn & Anjolein Schmeits, 2006. "Credit Ratings as Coordination Mechanisms," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 19(1), pages 81-118. [Downloadable!] (restricted)
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  15. Cantor, Richard, 2004. "An introduction to recent research on credit ratings," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2565-2573, November. [Downloadable!] (restricted)
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