Credit Ratings as Coordination Mechanisms

Authors

Arnoud W. A. Boot, University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen InstituteFollow
Todd T. Milbourn, Southern Methodist University (SMU) - SMU Cox School of BusinessFollow
Anjolein Schmeits, New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of FinanceFollow

Publication Date

1-29-2004

Abstract

In this paper, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings can serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a "focal point" for firms and their investors, and explore the vital, but previously overlooked implicit contractual relationship between a credit rating agency and a firm via its credit watch procedures. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of rating changes.

Document Type

Article

Disciplines

Finance

DOI

10.2139/ssrn.305158

Source

SMU Cox: Finance (Topic)

Language

English