Credit Rating Inflation and Firms’ Investments
نویسندگان
چکیده
Could inflated credit ratings that provide new information have adverse ex-ante real effects? If so, why? In a debt-rollover game featuring a feedback loop, we show that when the risky projects have high upside returns, the credit rating agency’s (CRA) ex-ante real effects are negative, despite of its positive informational effects. This arises from the CRAs feedback effects: it strategically assigns high ratings to firms with relatively bad fundamentals, allowing them to gamble for resurrection. Laxer rating standards may not be accompanied by higher rating inflation, and an appropriately designed cost scheme conditional on the firms failure may regulate CRAs.
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