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Institutional Environment and Sovereign Credit Ratings

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  • Alexander W. Butler
  • Larry Fauver

Abstract

We use a sample of 86 counties to examine the cross-sectional determinants of sovereign credit ratings. We find that the quality of a country's legal and political institutions plays a vital role in determining these ratings. A one-standard-deviation increase in our legal environment index results in an average credit rating increase of 0.466 standard deviations, even when we control for obvious factors such as GDP per capita, inflation, foreign debt per GDP, previous defaults, and general development. Although part of this effect is due to the legal environment's endogeneity, its relative importance is robust to endogeneity concerns. Copyright (c) 2006 Financial Management Association International.

Suggested Citation

  • Alexander W. Butler & Larry Fauver, 2006. "Institutional Environment and Sovereign Credit Ratings," Financial Management, Financial Management Association International, vol. 35(3), pages 53-79, September.
  • Handle: RePEc:bla:finmgt:v:35:y:2006:i:3:p:53-79
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    Cited by:

    1. Purificacion Parrado-Martinez & Antonio Parta Ureña & Pilar Gomez Fernandez-Aguado, 2014. "Usefulness of Financial Soundness Indicators for risk assessment: The case of EU member countries," Working Papers 14.01, Universidad Pablo de Olavide, Department of Financial Economics and Accounting (former Department of Business Administration).
    2. Céline Azémar & Rodolphe Desbordes, 2010. "Short-run Strategies for Attracting Foreign Direct Investment," The World Economy, Wiley Blackwell, vol. 33(7), pages 928-957, July.
    3. Dilek Teker & Aynur Pala & Oya Kent, 2013. "Determination of Sovereign Rating: Factor Based Ordered Probit Models for Panel Data Analysis Modelling Framework," International Journal of Economics and Financial Issues, Econjournals, vol. 3(1), pages 122-132.
    4. Suk‐Joong Kim & Eliza Wu, 2011. "International Bank Flows To Emerging Markets: Influence Of Sovereign Credit Ratings And Their Regional Spillover Effects," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 34(2), pages 331-364, June.
    5. Huong Dang, 2014. "How dimensions of national culture and institutional characteristics influence sovereign rating migration dynamics," ZenTra Working Papers in Transnational Studies 42 / 2014, ZenTra - Center for Transnational Studies.
    6. repec:pal:compes:v:59:y:2017:i:2:d:10.1057_s41294-017-0024-6 is not listed on IDEAS
    7. Luitel, Prabesh & Vanpée, Rosanne & De Moor, Lieven, 2016. "Pernicious effects: How the credit rating agencies disadvantage emerging markets," Research in International Business and Finance, Elsevier, vol. 38(C), pages 286-298.
    8. Aktug, R. Erdem & Nayar, Nandkumar (Nandu) & Vasconcellos, Geraldo M., 2013. "Is sovereign risk related to the banking sector?," Global Finance Journal, Elsevier, vol. 24(3), pages 222-249.
    9. Salvador, Carlos & Pastor, Jose Manuel & Fernández de Guevara, Juan, 2014. "Impact of the subprime crisis on bank ratings: The effect of the hardening of rating policies and worsening of solvency," Journal of Financial Stability, Elsevier, vol. 11(C), pages 13-31.
    10. Jelena Laušev & Aleksandar Stojanović & Nataša Todorović, 2011. "Determinants Of Debt Rescheduling In Eastern European Countries," Economic Annals, Faculty of Economics, University of Belgrade, vol. 56(188), pages 7-31, January –.
    11. Saurav Roychoudhury & Robert A. Lawson, 2010. "Economic freedom and sovereign credit ratings and default risk," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 2(2), pages 149-162, June.
    12. Emilian C. Miricescu & Lucian Ţâţu & Delia Cornea, 2016. "The Determinants of the Sovereign Debt Rating: Evidence for the European Union Countries," ECONOMIC COMPUTATION AND ECONOMIC CYBERNETICS STUDIES AND RESEARCH, Faculty of Economic Cybernetics, Statistics and Informatics, vol. 50(1), pages 175-188.
    13. Bernal, Oscar & Girard, Alexandre & Gnabo, Jean-Yves, 2016. "The importance of conflicts of interest in attributing sovereign credit ratings," International Review of Law and Economics, Elsevier, vol. 47(C), pages 48-66.
    14. Florian Berg & Paula Margaretic & Sébastien Pouget, 2016. "Sovereign Bond Spreads and Extra-Financial Performance: An Empirical Analysis of Emerging Markets," Working Papers Central Bank of Chile 789, Central Bank of Chile.
    15. Purificación Parrado-Martínez & Antonio Partal-Ureña & Pilar Gómez Fernández-Aguado, 2016. "Banking Soundness Indicators and Sovereign Risk in Time of Crisis: The Case of the European Union," The World Economy, Wiley Blackwell, vol. 39(8), pages 1172-1193, August.
    16. Autore, Don M. & Boulton, Thomas J. & Smart, Scott B. & Zutter, Chad J., 2014. "The impact of institutional quality on initial public offerings," Journal of Economics and Business, Elsevier, vol. 73(C), pages 65-96.
    17. Philipp Maier & Garima Vasishtha, 2008. "Good Policies or Good Fortune: What Drives the Compression in Emerging Market Spreads?," Staff Working Papers 08-25, Bank of Canada.
    18. Chen, Sheng-Syan & Chen, Hsien-Yi & Chang, Chong-Chuo & Yang, Shu-Ling, 2013. "How do sovereign credit rating changes affect private investment?," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4820-4833.
    19. Koerniadi, Hardjo & Krishnamurti, Chandrasekhar & Tourani-Rad, Alireza, 2015. "Cross-border mergers and acquisitions and default risk," International Review of Financial Analysis, Elsevier, vol. 42(C), pages 336-348.
    20. El-Shagi, Makram & von Schweinitz, Gregor, 2017. "Why they keep missing: An empirical investigation of rational inattention of rating agencies," IWH Discussion Papers 1/2017, Halle Institute for Economic Research (IWH).
    21. António Afonso & Pedro Gomes & Philipp Rother, 2006. "What “Hides” Behind Sovereign Debt Ratings?," Working Papers Department of Economics 2006/35, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    22. Davor Kunovac & Rafael Ravnik, 2017. "Are sovereign credit ratings overrated?," Working Papers 47, The Croatian National Bank, Croatia.
    23. Emara, Noha, 2012. "Inflation volatility, financial institutions and sovereign debt rating," MPRA Paper 68688, University Library of Munich, Germany.
    24. Markellos, Raphael N. & Psychoyios, Dimitris & Schneider, Friedrich, 2016. "Sovereign debt markets in light of the shadow economy," European Journal of Operational Research, Elsevier, vol. 252(1), pages 220-231.

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