Do Credit Rating Agencies Sacrifice Timeliness by Pursuing Rating Stability? Evidence from Equity Market Reactions to CreditWatch Events

Jenny Gu, Jeffrey S. Jones, Pu Liu

College of Business, University of Dallas, Irving, USA.
Department of Finance and General Business, Missouri State University, Springfield, USA.
Sam M. Walton College of Business, University of Arkansas, Fayetteville, USA.

DOI: 10.4236/tel.[phone]                

Abstract

In this paper we examine how well CreditWatch is used by credit rating agencies to balance two conflicting goals: rating timeliness and rating stability. Examining equity market reactions around CreditWatch events in 2002-2005, we find evidence that while CreditWatch has improved rating timeliness, its intended purpose has not been completely achieved. Equity prices start to change days before companies are listed on CreditWatch and abnormal equity returns of firms prior to being listed on CreditWatch are effective predictors of the ultimate change in ratings. The findings in the study suggest that in the pursuit of rating stability, rating agencies may have sacrificed rating timeliness.

Keywords

CreditWatch, Credit Ratings, Rating Stability, Rating Timeliness

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1]	Norden, L. and Weber, M. (2004) Informational Efficiency of Credit Default Swaps and Stock Markets: The Impact of Credit Rating Announcements. Journal of Banking and Finance, 28, 2565-2573. http://dx.doi.org/10.1016/j.jbankfin.2004.06.011
[2]	Hull, J., Predescu, M. and White, A. (2004) The Relationship between Credit Default Swap Spreads, Bond Yields, and Credit Rating Announcements. Journal of Banking and Finance, 28, 2789-2811. http://dx.doi.org/10.1016/j.jbankfin.2004.06.010
[3]	Reinhart, C.M. (2002) Credit Ratings, Default, and Financial Crises: Evidence from Emerging Markets. World Bank Economic Review, 16, 151-170. http://dx.doi.org/10.1093/wber/16.2.151
[4]	Sy, A. (2004) Rating the Rating Agencies: Anticipating Currency Crises or Debt Crises? Journal of Banking and Finance, 28, 2845-2867. http://dx.doi.org/10.1016/j.jbankfin.2004.06.012
[5]	Goldstein, M., Kaminsky, G. and Reinhart, C. (2000) Assessing Financial Vulnerability: An Early Warning System for Emerging Markets. Institute for International Economics.
[6]	Cheng, M. and Neamtiu, M. (2009) An Empirical Analysis of Changes in Credit Rating Properties: Timeliness, Accuracy and Volatility. Journal of Accounting and Economics, 47, 108-130. http://dx.doi.org/10.1016/j.jacceco.2008.11.001
[7]	Zweig, J. (2010) Melchior Palyi, the Man Who Called Financial Crisis—70 Years Earlier. The Intelligent Investor. Wall Street Journal. http://online.wsj.com/news/articles/SB10001424052748704405704575596382345085258
[8]	Cantor, R. (2001) Moody’s Investors Service’s Response to the Consultative Paper Issued by the Basel Committee on Bank Supervision “A New Capital Adequacy Framework”. Journal of Banking and Finance, 25, 171-185. http://dx.doi.org/10.1016/S0378-4266(00)00121-7
[9]	Cantor, R. and Mann, C. (2007) Analyzing the Tradeoff between Ratings Accuracy and Stability. Special Comment, Moody’s Investor Services.
[10]	Altman, E. and Rijken, H. (2004) How Rating Agencies Achieve Rating Stability. Journal of Banking and Finance, 28, 2679-2714. http://dx.doi.org/10.1016/j.jbankfin.2004.06.006
[11]	Loffler, G. (2005) Avoiding the Rating Bounce: Why Rating Agencies Are Slow to React to New Information. Journal of Economic Behavior and Organization, 56, 365-381. http://dx.doi.org/10.1016/j.jebo.2003.09.015
[12]	Cantor, R. and Mann, C. (2003) Are Corporate Bond Ratings Procyclical? Special Comment, Moody’s Investor Services.
[13]	Altman, E. and Rijken, H. (2006) The Added Value of Rating Outlooks and Rating Reviews to Corporate Bond Ratings. Working Paper, New York University Salomon Center.
[14]	Dichev, D.I. and Piotroski, J.D. (2001) The Long-Run Stock Returns Following Bond Ratings Changes. Journal of Finance, 5, 173-203. http://dx.doi.org/10.1111/0022-1082.00322
[15]	Hand, J.R.M., Holthausen, R. and Leftwich, R. (1992) The Effect of Bond Rating Agency Announcements on Bond and Stock Prices. Journal of Finance, 47, 733-752. http://dx.doi.org/10.1111/j.1540-6261.1992.tb04407.x
[16]	Holthausen, R. and Leftwich, R. (1986) An Analysis of the Informational Value of Bond Rating Changes. Journal of Financial Economics, 17, 57-89. http://dx.doi.org/10.1016/0304-405X(86)90006-1
[17]	Morgan, D.P. (2002) Rating Banks: Risk and Uncertainty in an Opaque Industry. American Economic Review, 92, 874-888. http://dx.doi.org/10.1257/00028280260344506
[18]	Liu, P. and Thakor, A. (1984) Interest Yields, Credit Ratings, and Economic Characteristics of State Bonds: An Empirical Analysis. Journal of Money Credit and Banking, 16, 344-351. http://dx.doi.org/10.2307/1992222
[19]	Brister, B., Kennedy, R. and Liu, P. (1994) The Regulation Effect of Credit Ratings on Bond Interest Yield: The Case of Junk Bonds. Journal of Business Finance and Accounting, 21, 511-531. http://dx.doi.org/10.1111/j.1468-5957.1994.tb00333.x
[20]	Jorion, P. and Zhang, G. (2007) Information Effects of Bond Rating Changes: The Role of the Rating Prior to the Announcement. Journal of Fixed Income, 16, 45-59. http://dx.doi.org/10.3905/jfi.2007.683317