Do Rating Agencies Cater? Evidence from Rating-Based Contracts

I examine whether rating agencies are more likely to cater to borrowers with rating-based performance pricing agreements (PPrating firms). This study uses data from Moody’s Financial Metrics on agency adjustments to investigate this prediction and exploits an unexpected adverse shock to firms’ credit risk as identification. The evidence is mixed. In the crosssection and for firms experiencing adverse shocks, agency adjustments are more favorable for PPrating firms. However, agency adjustments are less favorable when the agency’s reputational costs are high. Agency adjustments for PPrating firms are not associated with incrementally higher bond yields. ∗I am very grateful to the members of my dissertation committee: Ray Ball (chair), Phil Berger, Christian Leuz, and Doug Skinner, as well as Ryan Ball, Mary Barth, Alexander Bleck, Marshall Blume, Fabrizio Ferri, Joseph Gerakos, Valeri Nikolaev, Maarten Petermann, Joshua Ronen, Stephen Ryan, Regina Wittenberg, Joanna Wu, Sarah Zechman and Jerry Zimmerman. I also thank participants at the NBER summer session on credit rating agencies and Standard & Poor’s Academic Council Meeting as well as participants at accounting workshops at Boston College (Carroll School of Management), Columbia Business School, London Business School, McGill University (Desautels Faculty of Management), New York University (Stern School of Business), Northwestern University (Kellogg Graduate School of Management), University of Chicago (Booth), University of Michigan (Ross School of Business), University of Pennsylvania (Wharton), University of Rochester (Simon Graduate School of Business Administration), University of Toronto, Stanford Graduate School of Business, and Washington University (Olin Business School) for constructive suggestions, questions and feedback. I thank Andrew Tan and Hui Lin Tan for excellent research assistance. I am grateful for the financial support provided by the University of New York Stern School of Business, the University of Chicago Booth School of Business and the Deloitte Foundation. This paper was previously circulated under the title: The Impact of the Contractual Use of Ratings on the Rating Process Evidence from Rating Agency Adjustments. To contact me, email [email protected].