Impact of the Dodd-Frank Act on Credit Ratings

• In Event: Credit ratings
  In Paper Session: Credit Ratings

Abstract

We analyze the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on corporate bond ratings issued by credit rating agencies (CRAs). We find no evidence that Dodd-Frank disciplines CRAs to provide more accurate and informative credit ratings. Instead, following Dodd-Frank, CRAs issue lower ratings, give more false warnings, and issue downgrades that are less informative. These results are consistent with the reputation model of Morris (2001), and suggest that CRAs become more protective of their reputation following the passage of Dodd-Frank. Consistent with Morris (2001), we also find that our results are stronger for industries with low Fitch market share, where Moody’s and Standard & Poor’s have stronger incentives to protect their reputation (Becker and Milbourn (2011)). Our results are not driven by business cycle effects or firm characteristics, and strengthen as the uncertainty surrounding the passage of Dodd-Frank gets resolved. Overall, we caution against increasing the regulatory and compliance costs to CRAs for providing biased ratings.

Authors

• Leo Tang, Rutgers, The State University of New Jersey, Newark

• Valentin Dimitrov, Rutgers, The State University of New Jersey

• Darius Palia, Rutgers, The State University of New Jersey