Essays in Empirical Corporate Finance

Abstract

After the 2007 financial crisis, a big attention has been dedicated to credit ratings. Whether ratings are capable to provide the most precise and timely information is a question that has been tackled from different angles. The possibility to discipline credit ratings via a regulatory mechanism, the influence that ratings may play on corporate governance decisions and the information they deliver in comparison to other financial intermediaries are the main points that this dissertation aims to address. The first paper compares the behavior of standard or issuer-paid rating agencies, represented by Standard & Poors (S&P) to alternative or investor-paid rating agencies, represented by the Egan-Jones Ratings Company (EJR) after the Dodd- Frank Act regulation is approved. Results show that both S&P and EJR ratings are more conservative, stable and, on average, lower after the Dodd-Frank implementation. However, EJR ratings are higher for firms that may generate high revenue for the rater. Additionally, I find that, after the regulation, S&P cares more about its reputation. Exploiting a measure that captures the bond marketís ability to anticipate rating downgrades, I show that, after Dodd-Frank, bond market anticipation decreases for S&P but increases for EJR, suggesting that S&P ratings are timelier. Finally, I study how the bond market responds to rating changes and how firms perceive ratings in their decision to issue debt in the post-Dodd-Frank period. Results suggest that both S&P downgrades and upgrades generate a greater bond market re- sponse. On the contrary, only EJR upgrades have a magnified effect on bond market returns. The greater informativeness of S&P ratings after Dodd-Frank is confirmed by the meaningful impact of these ratings on firm debt issuance. The second paper (coauthored with Annamaria C. Menichini) studies the relationship between credit rating changes and CEO turnover beyond firm performance. Using an adverse selection model that explicitly incorporates rating change related turnover, our model predicts that a downgrade triggers turnover, more so the lower the managerial entrenchment, but that this relation is weaker when the report provided by the rating agency is more reliable. Our empirical results support these predictions. We show that downgrades explain forced turnover risk, with the new CEO chosen outside the firm that has received the negative credit rating change. In addition, we find that the relation between rating changes and management turnover is stronger when the degree of managerial entrenchment is low, for firms characterized by a high level of investment and for firms less exposed to rating fees. Finally, we show that this relation has weakened in the post-2007 crisis period, in coincidence with the increased reputational concerns of the rating agencies. The results are robust to endogeneity concerns. The third paper (coauthored with Thomas J. Chemmanur and Igor Karagodsky) focuses on equity analysts, issuer-paid and investor-paid ratings. Equity analysts' forecasts and ratings assigned by issuer-paid credit rating agencies such as Standard and Poorís (S&P) and by investor-paid rating agencies such as Egan and Jones (EJR) all involve information production about the same underlying set of firms, even though equity analysts focus on cash flows to equity and bond ratings focus on cash flows to bonds. Further, the two types of credit rating agencies differ in their incentives to produce and report accurate information signals. Given this setting, we empirically analyze the timeliness and accuracy of the information signals provided by each of the above three types of financial intermediary to their investor clienteles and the information flows between these intermediaries. We find that the information signals produced by EJR are the most timely (on average), and seem to anticipate the information signals produced by equity analysts as well as by S&P. We find that changes in leverage are associated with lower EJR ratings but higher equity analysts' recommendations; further, credit rating changes by EJR have the largest impact on firms' investment levels. We also document an investor attention effect (in the sense of Merton, 1987) among stock and bond market investors in the sense that changes in equity analyst recommendations have a higher impact than either EJR or S&P ratings changes on the excess returns on firm equity, while EJR rating changes have a higher impact on bond yield spreads than either S&P ratings changes or changes in equity analyst recommendations. Finally, we analyze differences in bond ratings assigned to a given firm by EJR and S&P, and find that these differences are positively related to the standard proxies for disagreement among stock market investors.