Creditworthiness risk over years: The evolution of credit rating standards

• Author: Alessandro Cafarelli
• Date: 01 October 2020
• Published date: 01 October 2020
• DOI: http://doi.org/10.1002/jcaf.22461

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Creditworthiness risk over years: The evolution of credit

rating standards

Alessandro Cafarelli

SDA Bocconi School of Management,

Accounting Control Corporate and Real

Estate Finance Department, Milan, Italy

Correspondence

Alessandro Cafarelli, SDA Bocconi School

of Management, Accounting Control

Corporate and Real Estate Finance

Department, Via Bocconi, 8 –20136,

Milan, Italy.

Email: alessandro.cafarelli@unibocconi.it

Abstract

The last financial crisis has increased the attention into the business of credit

rating agencies. In this paper, I investigate the evolution of credit rating stan-

dards to measure if rating agencies have moved to different standards over

years. First, I present a rating regression model where I employ specific explan-

atory variables to measure how they impact on ratings outcome. Next, I exam-

ine long term issuer credit rating from 1985 to 2013 to analyze how the credit

rating agencies have modified their standards over years. I focus on the

dynamics of the time variable and I find credit rating agencies strengthen their

standards over years since they assign more conservative issuer ratings, hold-

ing the companies stable characteristics.

KEYWORDS

credit ratings, investor-paid rating agencies, rating process, rating quality, rating standards

1|INTRODUCTION

Credit ratings play an important role in capital markets

since they measure the creditworthiness of issuers and

different financial instruments. Ratings are issued by

credit rating agencies which are independent providers of

credit opinions (ESME, 2008) and several market partici-

pants, that is, investors, borrowers, and governments,

rely also on credit ratings when they assume investments

and financial decisions. Nazareth (2003) recognizes that

credit ratings “affect securities markets in many ways,

including an issuer's access to capital, the structure of

transactions, and the ability of fiduciaries and others to

make particular investments.”Standard & Poor's, one of

the leading credit agencies in the market, states that the

ratings are useful since they explain company's credit-

worthiness to outside agents and increase company

access to new markets.

In recent years, the role of credit ratings has been

acutely criticized. In fact, following the bankruptcy of

global players such as Enron, Parmalat and, most

recently, Lehman Brothers and after the financial turmoil

of 2008, credit ratings have come under extensive

attention and financial community has questioned

whether their procedures were able to adapt to the

changes in financial markets and to fully monitor the

creditworthiness of more complex financial products.

Indeed, the inability of rating agencies to accurately

gauge the creditworthiness of subprime MBS (Efing &

Hau, 2015; He, Qjan, & Strahan, 2012), gave birth to fur-

ther questions about the accuracy of credit ratings and

the existence of concrete bias in their process (Bar-Isaac &

Shapiro, 2013). A central concern that cast serious doubts

over the role of rating agencies in the financial market, is

whether their operating procedures and the lack of

worldwide unique regulatory framework contributed to

investor losses.

In this paper, I estimate a rating regression model to

measure the impact of selected explanatory variables on

credit ratings. The intent of my analysis is to test poten-

tial different approaches of credit rating agencies evaluat-

ing the creditworthiness of firms, over a vast time

horizon. For this purpose, I collect credit rating data from

1985 to 2013, which means over a period of 29 years.

Received: 12 February 2020 Revised: 29 June 2020 Accepted: 3 July 2020

DOI: 10.1002/jcaf.22461

48 © 2020 Wiley Periodicals LLC J Corp Acct Fin. 2020;31:48–59.wileyonlinelibrary.com/journal/jcaf