Does reputational capital affect credit rating agencies?: empirical evidence from a natural experiment in China

The subprime mortgage crisis of 2007–2008 has led major economies to reform their credit rating regulations, and China is not an exception. This paper employs a difference-in-difference research design to investigate whether the reputational capital of credit rating agencies affects their rated bonds. The first market-oriented evaluation of the Chinese inter-bank bond market is chosen as the source of the exogenous reputational shock. Using the medium term notes rated by China Chengxin International Credit Rating as benchmarks, a causal relationship is identified revealing that the average yield spread at the issuance of medium term notes, as rated by China Lianhe Credit Rating, increases by between 0.23 and 0.33% due to its decreased reputational capital. This research provides favorable evidence for the recent reform measures that aim to increase the disciplinary power of reputational capital.