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 rolls

over short-term debt for a long-term investment, focusing on interactions between a CRA's

rating, creditors' debt rollover decisions, and a firm's moral hazard. Because credit ratings

are partially verifiable, a high credit rating remains an informative positive signal, despite

common knowledge of rating inflation. However, due to creditors' belief dispersion, inflated

credit ratings may provide firms with incentives to \gamble for resurrection," leading to

severe moral hazard. Our theory generates several new empirical predictions; in particular,

credit ratings are more inflated for opaque firms that dominated the 2007 -2009 financial

crisis. Ultimately, we discuss how certain policies, such as verifying the firm's investment

and a stress test, can regulate the credit rating industry and mitigate CRAs' adverse effects.