Mandatory financial information disclosure and credit ratings

When firms are forced to publicly disclose financial information, credit rating agencies are supposed to improve their risk assessments. Theory predicts such an information quality effect but also an adverse reputational concerns effect because credit analysts may become increasingly concerned about alleged rating failures. We empirically examine these predictions using a large scale quasi-natural experiment in Germany, where firms were required to publicly disclose annual financial statements. Consistent with the reputational concern hypothesis, we find an average increase in credit rating downgrades that is entirely driven by changes in the discretionary assessment of the credit analysts rather than changes in firm fundamentals. Analysts tend to give positive private information a lower weight in their risk assessment, while they put a higher weight on negative public information. A last set of results indicate that professional credit providers understand that the resulting downgrades are not warranted, while unsophisticated lenders did indeed reduce the provision of trade credit in response to the rating downgrades.