The Impact of the Dodd Frank Act on the Determinants of Credit Rating Quality

Paul John Marcel Klumpes, Kostas Konstantinos Eleftheriou, Iliya Komarev, Anne-lise Ronsse

Publikation: Working paper/PreprintWorking paperForskning

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Abstract

The Dodd Frank Act of 2010 imposed, for the first time, legal liability of credit rating agencies for their judgments, and required public disclosure of rating methodologies. The latter are based on anchoring and adjustment heuristics and are potentially subject to conservatism causing rating agency judgments to shift from risk aversion to loss aversion. Using behavioral decision-making theories, we predict that loss averse rating agencies are likely not to upgrade firms with volatile history of credit rates. We also predict that the loss aversion is mitigated by the passage of the Dodd Frank Act. Further, we expect that the process of credit rating anchoring exploits in a more rational way the information about issuing firms’ cash-flows, as opposed to the traditional accounting earnings.
Our empirical analysis is based on examining variations in credit ratings for a panel of large US debt issuing firms. Our findings corroborate the behavioral conservatism of rating agencies with regard to the debt issuer’s prior credit rating volatility. However, this effect only slightly declines post-Dodd Frank Act. Moreover, our findings do not provide consistent support for the expected effect of the Dodd-Frank Act in terms of reliance on cash flow quality rather than earnings quality.
OriginalsprogEngelsk
Antal sider37
StatusIkke-udgivet - 2 dec. 2022

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