Credit ratings and politics
Does partisan perception affect the actions of credit rating analysts? This is the question that Kempf and Tsoutsoura are trying to answer in this paper. In order to do this they test whether the rating actions of credit analysts depend on their political alignment with the U.S. president. They compile a novel hand-collected dataset that links credit rating analysts to the ratings they issue, as well as to information on party affiliation from voter registration records. Their sample consists of 557 corporate credit analysts with information on their party affiliation, working at Fitch, Moody’s, and Standard and Poor’s (S&P) between 2000 and 2018. They find:
- Analysts who are not affiliated with the president’s party are more likely to adjust ratings downward, relative to other analysts covering the same firm at the same point in time.
- Firms rated by analysts who transition from aligned to misaligned with the president experience a significant decrease in firm investment around presidential elections.
- Partisan beliefs about how the economy will perform with the policies of the U.S. president affect the credit risk of firms whose fundamentals most affected by changing aggregate economic conditions.
Partisan Professionals: Evidence from Credit Rating Analysts
Authors: Elisabeth Kempf, Margarita Tsoutsoura
From: University of Chicago, Cornell University
Credit rating inflation
The BBB-rated segment of the bond market has more than tripled in size to $3.5 trillion from 2008 to 2020. BBB-rated bonds account now for 55% of all investment-grade debt in the US. In this paper, Acharaya et al. argue that this BBB bond growth has been driven by prospective “fallen angels” i.e. risky firms just above the investment-grade cutoff which are vulnerable to downgrades. They show that these fallen angels have benefited from investors subsidizing their bond financing, especially during periods of monetary easing, and that this subsidy appears to be driven by ratings agencies inflating their ratings when these firms engage in M&A. The intuition behind this claim is that although these M&A transactions are value destroying, they are valued by bond investors because they delay downgrades of prospective fallen angels. What are the effects of such an increase of BBB rated bonds on the real economy?
- At the firm-level, they show that vulnerable firms, in general, have lower employment growth and investment levels than non-vulnerable firms.
- Subsidized firms grow disproportionately large and increase their market share by reducing the markup on their products. The resulting spillover effects force their competitors, including high-investment grade competitors, to reduce employment, investment, markups, and sales growth.
- Finally, there is an associated buildup of vulnerabilities in the corporate sector which could become important after a shock.
Exorbitant Privilege? The Bond Market Subsidy of Prospective Fallen Angels
Authors: Viral V. Acharya, Ryan Banerjee, Matteo Crosignani, Tim Eisert, Renée Spigt
From: NYU Stern, BIS, New York Fed, Erasmus Rotterdam
