Geographic Location of the Firm and Credit Rating Accuracy

• In Event: Audit Effectiveness and Market Reactions

Abstract

We document that availability of soft information as a result of shorter distance between firm headquarters and rating agency headquarters enables the bond rating analysts to attain higher accuracy of credit ratings. Our analyses show that for each 100 kilometers the firm is away from the rating agency headquarters, the likelihood of missing defaults (type 1 error) increases by 6.0 percent, and the likelihood of giving false warnings (type 2 error) increases by 2.2 percent. We also find that the positive relationship between distance and missed defaults is stronger for firms with higher complexity, proxied by firm product diversity, and lower visibility, proxied by analysts’ following. Additionally, we find that the rating analysts are aware that they lack soft information if firm headquarters is away from their headquarters and they adjust their ratings lower for these firms. But this rating adjustment does not decrease the chances of missed defaults. The results on investor reaction show that investors’ positive reaction to ratings upgrades is significantly higher for the New York City (NYC) firms compared to the firms farther away from NYC, but there is no significant difference in investor reaction to the ratings downgrades whether the firms are located in NYC or farther away from NYC.

Authors

• Bikki Jaggi, Rutgers, The State University of New Jersey, Newark

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