Publications
Publications
- 2021
- HBS Working Paper Series
Do Rating Agencies Behave Defensively for Higher Risk Issuers?
By: Samuel B. Bonsall, Kevin Koharki, Pepa Kraft, Karl A. Muller and Anywhere Sikochi
Abstract
We examine whether rating agencies are defensive toward issuers with a higher likelihood of default. We find that agencies’ qualitative soft rating adjustments are more accurate as issuers’ default risk grows, as evidenced by the adjustments leading to lower Type I and Type II error rates and better prediction of default and default recovery losses. We also find that soft adjustments’ relevance increases with issuers’ default risk, as evidenced by the adjustments being more predictive of initial offering yields and leading to a greater market reaction to rating changes. Further, we find that the rating agencies assign better educated and more experienced analysts to higher risk issuers, providing evidence of one mechanism used by the rating agencies to generate more accurate and relevant soft adjustments. Overall, our study suggests that as the likelihood of issuer default grows the threat of reputational harm from discovered rating failures increasingly mitigates some of the rating agencies’ opportunistic behavior incentivized by the issuer-pay model.
Keywords
Credit Rating Agencies; Default; Default Risk; Soft Rating Adjustments; Credit; Performance Evaluation; Measurement and Metrics; Financial Institutions; Risk Management; Behavior
Citation
Bonsall, Samuel B., Kevin Koharki, Pepa Kraft, Karl A. Muller, and Anywhere Sikochi. "Do Rating Agencies Behave Defensively for Higher Risk Issuers?" Harvard Business School Working Paper, No. 17-050, December 2016. (Revised August 2021.)