Finance Seminar（2015-17）

Topic: Credit Rating Inflation

Speaker: Chong Huang, University of California, Irvine

Time: Thursday, 4 June, 10:30-11:45

Location: Room 217, Guanghua Building 2

Abstract: Credit rating inflation lies at the heart of public debates over credit rating agencies'(CRAs) economic effects and regulation. We analyze a CRA's ratings to a firm that rollsover short-term debt for a long-term investment, focusing on interactions between a CRA'srating, creditors' debt rollover decisions, and a firm's moral hazard. Because credit ratingsare partially verifiable, a high credit rating remains an informative positive signal, despitecommon knowledge of rating inflation. However, due to creditors' belief dispersion, inflatedcredit ratings may provide firms with incentives to \gamble for resurrection," leading tosevere moral hazard. Our theory generates several new empirical predictions; in particular,credit ratings are more inflated for opaque firms that dominated the 2007-2009 financialcrisis. Ultimately, we discuss how certain policies, such as verifying the firm's investmentand a stress test, can regulate the credit rating industry and mitigate CRAs' adverse effects.