Bo Becker

How did increased competition affect credit ratings

The credit rating industry has historically been dominated by just two agencies, Moodys and Standard & Poors, leading to long-standing legislative and regulatory calls for increased competition. The material entry of a third rating agency (Fitch) to the competitive landscape offers a unique experiment to empirically examine how increased competition affects the credit ratings market. What we find is relatively troubling. Specifically, we discover that increased competition from Fitch coincides with lower quality ratings from the incumbents: Rating levels went up, the correlation between ratings and market-implied yields fell, and the ability of ratings to predict default deteriorated. We offer several possible explanations for these findings that are linked to existing theories.

The Effect of Financial Development on the Investment Cash Flow Relationship: Cross-Country Evidence from Europe

Abstract We investigate if financial development eases firm level financing constraints in a cross-country data set covering much of the European economy. The cash flow sensitivity of investment is lower in countries with better-developed financial markets. To deal with potentially serious biases, we employ a difference-in-difference methodology. Subsidiaries of other firms have access to internal capital markets and hence depend less on the external financial environment. As predicted, the benefit of financial development is smaller in subsidiary firms. This shows that financial development can mitigate financial constraints, and sheds light on the link between financial and economic development.

Estimating the Effects of Large Shareholders Using a Geographic Instrument

Large shareholders may play an important role for firm performance and policies, but identifying this empirically presents a challenge due to the endogeneity of ownership structures. We develop and test an empirical framework that allows us to separate selection from treatment effects of large shareholders. Individual blockholders tend to hold blocks in public firms located close to where they reside. Using this empirical observation, we develop an instrument (the density of wealthy individuals near a firms headquarters) for the presence of large, nonmanagerial individual shareholders in firms. These shareholders have a large impact on firms, controlling for selection effects.

Bad Times, Good Credit

Asymmetric information between lenders and borrowers is understood to be a key friction in credit markets. Can amplified information problems explain why the supply of corporate credit contracts in recessions and crises? Alternatively, asymmetric information may be reduced by economic slowdowns. We test these opposing views of information frictions in the credit market using data on lending from a large bank, through two business cycles. We find that this banks’ ability to sort borrowers by credit quality is best in bad times. This suggests that information frictions are counter-cyclical in corporate credit markets.

Non-Rating Revenue and Conflicts of Interest

Rating agencies produce ratings used by investors, but obtain most of their revenue from issuers, leading to a conflict of interest. We employ a detailed panel data set on the use of non-rating services, and the associated payments, in India, to test to what extent this conflict affects credit ratings. Rating agencies rate issuers that hire them for non-rating services 0.3 notches higher (than agencies that are not hired for such services). Also, within rating categories, default rates are higher for firms that have paid for non-rating services. Both these effects are larger the larger the amount paid for non-rating services is. These results suggest that issuers which hire agencies for consulting services receive higher ratings despite not having lower credit risk.