The impact of issuer-pay on corporate bond rating properties

Evidence from Moody's and S&P's initial adoptions

Research output: Contribution to journalArticle

17 Citations (Scopus)

Abstract

This study examines whether and how the properties of corporate bond ratings change following Moody[U+05F3]s and S&P[U+05F3]s adoptions of the issuer-pay business model in the early 1970s. Regulators and debt market observers have criticized the issuer-pay model for creating an independence problem. However, the issuer-pay model allows for economic bonding between rating agencies and issuers through explicit contractual arrangements, which should improve the flow of nonpublic information. Using a difference-in-difference research design, I find that more optimistic ratings by issuer-pay rating agencies predict greater future profitability, differences between the ratings of issuer-pay and investor-pay rating agencies are associated with narrower secondary bond market bid-ask spreads, and that issuer-pay rating agencies become relatively more accurate and timely predictors of default compared to investor-pay agencies after the adoption of issuer-pay. These results reinterpret the recent findings of optimistic ratings by Jiang et al. (2012) as consistent with more informative bond ratings.

Original languageEnglish (US)
Pages (from-to)89-109
Number of pages21
JournalJournal of Accounting and Economics
Volume57
Issue number2-3
DOIs
StatePublished - Apr 1 2014

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Bond ratings
Corporate bonds
Rating agencies
Rating
Investors
Debt
Bid/ask spread
Bond market
Profitability
Economics
Business model
Research design
Predictors
Difference-in-differences
Observer

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

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title = "The impact of issuer-pay on corporate bond rating properties: Evidence from Moody's and S&P's initial adoptions",
abstract = "This study examines whether and how the properties of corporate bond ratings change following Moody[U+05F3]s and S&P[U+05F3]s adoptions of the issuer-pay business model in the early 1970s. Regulators and debt market observers have criticized the issuer-pay model for creating an independence problem. However, the issuer-pay model allows for economic bonding between rating agencies and issuers through explicit contractual arrangements, which should improve the flow of nonpublic information. Using a difference-in-difference research design, I find that more optimistic ratings by issuer-pay rating agencies predict greater future profitability, differences between the ratings of issuer-pay and investor-pay rating agencies are associated with narrower secondary bond market bid-ask spreads, and that issuer-pay rating agencies become relatively more accurate and timely predictors of default compared to investor-pay agencies after the adoption of issuer-pay. These results reinterpret the recent findings of optimistic ratings by Jiang et al. (2012) as consistent with more informative bond ratings.",
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