Rating Agency Reputation, the Global Financial Crisis, and the Cost of Debt
Han, Seung Hun, Pagano, Michael S., Shin, Yoon S., Financial Management
Why do foreign firms obtain credit ratings by global rating agencies rather than from their home country's rating agencies even though global raters typically assign lower credit ratings when these foreign firms issue bonds in their home currencies? We find that bonds rated by a global agency decreased yields 11-14 basis points (bps) when compared to those rated by Japanese rating agencies but, during the 2007-2009 financial crisis, the yields on these Japanese bonds increased 12-17 bps, thus fully negating the advantage of obtaining a bond rating from a global rater This suggests that the reputation of global rating agencies declined during the 2007-2009 crisis period.
Credit rating agencies evaluate debt issuers and specific bond issues in two ways: 1) by assessing default probabilities with private and public information provided by issuers, and 2) informing financial markets of their evaluations through bond ratings. Both investors and issuers believe that rating agencies have specialized skills related to assessing credit worthiness and default risk. Thus, rating agencies help reveal important additional information about a firm to the credit markets in the form of ratings and help reduce information asymmetry between the issuing firm and potential investors in the new debt issue. (1) The influence of global rating agencies, such as Moody's and S&P, is quite substantial in that they control nearly 80% of the global credit ratings market (Wall Street Journal, 2003). (2)
Although there is some evidence regarding the influence of global and domestic rating agencies in domestic stock markets, more can be done in this area, particularly with respect to the second largest bond market in the world, Japan. (3) For example, Li, Shin, and Moore (2006) find that the stock prices of Japanese firms react more strongly to rating downgrades by global rating agencies than by the two major Japanese rating agencies. Accordingly, Li et al. (2006) suggest that global rating agencies are more influential and have a greater reputation than domestic agencies in Japan. In addition, Shin and Moore (2003) determine that the ratings of Japanese firms by global agencies are lower than those assigned by Japanese agencies. (4) Further, Shin and Moore (2008) conclude that even though Moody's and S&P assign lower credit ratings to Canadian firms than DBRS (Dominion Bond Rating Service), a Canadian credit rating agency, the former are more influential than the latter in the Canadian capital market. Therefore, we examine why foreign firms obtain ratings from global agencies in spite of receiving potentially lower ratings. We do this by studying how a rating from a global agency affects the cost of debt for newly issued, yen-denominated Japanese corporate bonds.
The ratings from global agencies, such as S&P and Moody's, are important for several types of investors. For example, when money market mutual funds in the United States purchase commercial paper, they must buy investment-grade issues rated by at least two Nationally Recognized Statistical Rating Agencies (NRSROs). (5) The Securities and Exchange Commission (SEC) also allows commercial banks to use credit ratings assigned by NRSROs in calculating their capital requirements. In addition, the SEC has tried to regulate the ratings of structured credit products such as mortgage-backed securities, asset-backed securities, as well as collateralized debt obligations after the subprime mortgage crisis began in 2007 and is contemplating additional regulations for short- and long-term corporate credit ratings. The SEC issued nine NRSRO certifications as of December 2011 and although Moody's, S&P, and Fitch received NRSRO status in 1975, the two main Japanese rating firms, Rating & Investment Information (R&I) and Japanese Credit Rating Agency (JCR), obtained this recognition in 2007. R&I and JCR are the first non-Anglo-American rating agencies to acquire this NRSRO designation. …