Academic journal article Academy of Accounting and Financial Studies Journal

The Impact of Split Bond Ratings on Accounting Research Results: Some Additional Evidence and Some Preliminary Insights

Academic journal article Academy of Accounting and Financial Studies Journal

The Impact of Split Bond Ratings on Accounting Research Results: Some Additional Evidence and Some Preliminary Insights

Article excerpt

ABSTRACT

A split bond rating occurs when at least two bond rating agencies (e.g., Moody's and S&P) disagree on the rating of a particular bond issue. Prior accounting studies that employ bond ratings (as either independent or dependent variable measures) do not use more than one source of bond ratings (e.g., Khurana and Raman, 2003; and, Brandon et al., 2004) and thus do not minimize potential bond rating agency bias-at least with respect to the split rated bonds included in such accounting studies. Admittedly, while the extent, if any, of the potential bias associated with using only one data source has yet to be quantified, it appears that some bias exists given that a majority of the research to date suggests that Moody's bond ratings are more conservative than S&P bond ratings. Consistent with the majority of the previous bond rating research results, the empirical results of our study also support the conclusion that Moody's bond ratings are generally more conservative than S&P bond ratings. This finding leads us to suggest that accounting researchers should employ multiple bond rating sources when conducting research on bond ratings to minimize the potential for bond rating agency bias.

INTRODUCTION

Dandapani and Lawrence (2007) indicate that an investor uses bond ratings to measure the relative credit risk of bonds. Additionally, they state that bond ratings affect a firm's access to capital as well as its cost of capital. Further, they suggest that two major credit rating agencies dominate the market in rating publicly traded bonds - Moody's Investors Service (Moody's) and Standard & Poor's (S&P). When Moody's and S&P (or some other credit rating agencies) disagree on the rating of a particular bond issue, a "split rating" is said to have occurred.

Livingston et al. (2007) indicate that about 20% of U.S. corporate and municipal bonds have letter split ratings (e.g., Ba versus B; and, BB versus B) while approximately 50% of notch-level ratings are split (e.g., B2 versus B3; and, B versus B-). Unfortunately, accounting studies that employ bond ratings (as either independent or dependent variable measures) do not address the issue of split bond ratings because such studies do not use more than one bond rating source (e.g., Khurana and Raman, 2003; and, Brandon et al., 2004). Thus the results of such accounting studies may be influenced by bond rating agency bias. Stated otherwise, we believe that the use of only one bond rating source may bias (to some unknown degree) the results of accounting studies employing bond ratings since such accounting studies most likely include split rated bond issues. Accordingly, to gain insights regarding the potential influence of split ratings on the results of previous accounting studies and to provide guidance with respect to future accounting studies employing bond ratings, we use the following strategy. First, we identify and summarize recent accounting studies that employ bond ratings. Second, we review the split bond rating literature. Third, we provide additional evidence to support the majority view that Moody's bond ratings are more conservative than S&P bond ratings. Finally, we discuss the potential limitations of not using multiple bond rating sources when conducting accounting studies employing bond ratings.

RECENT ACCOUNTING STUDIES

We noted two recent studies that we believe represent the current methodological state of accounting research employing bond ratings - Khurana and Raman (2003) and Brandon et al. (2004). Key methodological characteristics of these two studies are summarized in Table 1. Khurana and Raman (2003) use S&P bond ratings (n = 667) as one of their independent variables and "yield to maturity" as their dependent variable in a regression analysis. In contrast, Brandon et al. (2004) use Moody's bond ratings (n = 333) as their dependent variable; they employ logistic regression since bond rating data are polychotomous. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.