Credit Ratings as Coordination Mechanisms
AbstractIn this paper, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings can serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a "focal point" for firms and their investors. We explore the vital, but previously overlooked implicit contractual relationship between a credit rating agency and a firm. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of ratings changes, the discreteness in funding cost changes, and the effect of the focus of organizations on the efficacy of credit ratings.
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Bibliographic InfoPaper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number 457.
Length: 34 pages
Date of creation: 15 Mar 2002
Date of revision:
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coordination; credit ratings; multiple equilibria;
Other versions of this item:
- G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2002-06-18 (All new papers)
- NEP-FIN-2002-06-18 (Finance)
- NEP-FMK-2002-06-18 (Financial Markets)
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