We apply prospect theory to examine the impact of regulatory intervention and the provision of ancillary services impact credit rating agency sentiment towards debt issuing firms. Relative to neutral sentiment firms, we predict asymmetric sentiment behaviour in credit upgrade versus downgrade decisions is related to the credit rating quality of the issuer. Our analysis focuses on how this sentiment behaviour was impacted by increased regulatory intervention over time, resulting from an earnings quality focus in the post-Enron, pre-financial crisis period, towards a cash flow quality focus in the post-financial crisis period. We predict that the provision of ancillary services mitigates credit rating sentiment away from real cash flow towards cosmetic earnings focus, for non-speculative credit issuers. Consistent with these predictions, we find that the (i) propensity to be investment grade is linked to earnings (cash flow) quality in the pre-crisis (post-crisis) period, (ii) credit rating upgrades versus neutral sentiment firms are related to cosmetic earnings quality for investment grade and speculative firms in the pre-crash period but only for speculative firms in the post-crash period and (iii) credit down grade firms (compared to neutral sentiment firms) are related to cosmetic earnings for investment and threshold firms, as opposed to fundamental leverage and real cash flow quality factors for speculative firms. These findings suggest that the new regulations did not succeed in reducing the mitigating incentives facing credit rating agencies sentiment towards ancillary services offered to client associations. More generally our findings bear on the importance of credit rating sentiment in the rating process and on the relative and incremental salience on cash based versus accounting based accruals quality measures.
|Status||Udgivet - 2022|