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An Empirical Analysis of Changes in the Relative Timeliness of Issuer-Paid vs. Investor-Paid Ratings

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  • Erik Berwart
  • Massimo Guidolin
  • Andreas Milidonis

Abstract

We investigate the lead-lag relationships between issuer- and investor-paid credit rating agencies, in the aftermath of the regulatory reforms undertaken in the U.S. between 2002 and 2006 —including watch list inclusions and outlooks. First, we find that the lead effect of investor-paid over issuer-paid credit rating agencies has weakened: in recent years, causality has turned bi-directional. Second, when changes in outlooks are included, we find evidence of a less conservative behavior by issuer-paid agencies, when compared to their rating behavior. Third, stock prices manifest statistically significant abnormal reactions to downgrades of all agencies; however, abnormal negative returns are significantly higher for investor-paid downgrades. Our results support the hypothesis that when issuer-paid agencies have seen their market power threatened by tighter regulations, they have felt incentives to improve the quality and timeliness of their ratings. However, event studies show that markets still price stocks under the assumption that investor-paid rating actions carry superior information. JEL Classification Codes: G24, G28. Keywords: rating agencies, timeliness, issuer-paid agencies, investor-paid business model, NRSRO

Suggested Citation

  • Erik Berwart & Massimo Guidolin & Andreas Milidonis, 2013. "An Empirical Analysis of Changes in the Relative Timeliness of Issuer-Paid vs. Investor-Paid Ratings," Working Papers 482, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  • Handle: RePEc:igi:igierp:482
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    References listed on IDEAS

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    Cited by:

    1. Michaelides, Alexander & Milidonis, Andreas & Nishiotis, George P. & Papakyriakou, Panayiotis, 2015. "The adverse effects of systematic leakage ahead of official sovereign debt rating announcements," Journal of Financial Economics, Elsevier, vol. 116(3), pages 526-547.
    2. Milidonis, Andreas, 2013. "Compensation incentives of credit rating agencies and predictability of changes in bond ratings and financial strength ratings," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3716-3732.

    More about this item

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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