The Effect of Corporate Governance on Credit Ratings: Evidence from China’s Bond Market

• In Event: Governance and managerial Issues: International Evidence
  In Paper Session: Governance and Managerial Issues: International Evidence

Abstract

This paper investigates the effect of corporate governance on credit ratings (both bond ratings and issuer ratings) in China, the second largest economy in the world. In addition to financial risks, do credit rating agencies consider corporate governance, and how do they react to various features of corporate governance? Bondholder’s may consider two kinds of agency problems: the conflict between managers and all stakeholders, and the conflict between shareholders and bondholders. This paper documents that corporate governance affects credit ratings. After controlling for financial characteristics, we find that issuer ratings are positively related to the ultimate controlling shareholder’s ownership, the percentage of shares by the state and dual-listing, and negatively related to the relative scale of audit fee. These results indicate that, different from the shareholder’s aim to maximize the firm value, the biggest concern of a bondholder is the guarantee of the coverage of debt service costs and principal payments, resulting in state-owned enterprise status having a positive impact on credit rating. The relative scale of audit fee can be seen as a sign of interest binding the client firm and the audit firm, and credit rating agencies perceive that such interest binding threatens the independence of auditing and the quality of financial reporting. We also document that bond-specific characteristics are critical to bond ratings, with collateral playing a key role in enhancing the credit of the bond.

Authors

• William Bradford, University of Washington

• Chao Chen, Fudan University

• Beini Zhang, Fudan University

• Yang Zhao, Fudan University