Qualitative Disclosure and Credit Analysts’ Soft Rating Adjustments

Using both dictionary-based and topic modelling approaches, we examine whether and how credit analysts use borrowers’ qualitative disclosures to extract information pertaining to credit risk in making their assessments. We first decompose publicly-available ratings into qualitative factors (soft adjustments) and quantitative factors (hard adjustments). We find that credit analysts’ soft adjustments, but not the hard adjustments, reflect information in borrowers’ qualitative disclosures. Next, our results indicate that the association between firms’ qualitative disclosures and soft adjustments varies depending upon the rating agency’s reliance on public disclosure, access to management, and overall market uncertainty. Finally, we examine whether analysts’ use of credit risk-relevant information from borrowers’ qualitative disclosures increases the informativeness of credit rating downgrades. We find that the credit rating downgrades of borrowers that provide more qualitative disclosures are more informative than those who do not; however, the increase in informativeness diminishes after the Dodd-Frank Act, when legal liability and regulatory penalties for credit rating agencies increased.