This study assesses the validity of widespread criticisms of the large, “nationally recognized” credit rating agencies (CRAs). The accounting scandals of 2000-02, in particular the highly publicized failure of Enron in December 2001, led many to question their competence and the value of their ratings. This paper evaluates important criticisms of the CRAs discussed in a recent Securities and Exchange Commission (SEC) staff report by using evidence from empirical research studies, and suggests many promising subjects for future research. The analysis given in this paper, and the results of the suggested research (when available), should be of particular interest to lawmakers and regulators who are responsible for determining whether and to what extent the credit rating industry should be subject to statutory and regulatory oversight. Although little rigorously gathered empirical evidence supports the criticisms, many issues remain unresolved. Powerful tests related to potential conflicts of interest and alleged unfair practices are exceptionally difficult to design, and the alleged deficiencies of rating agencies' disclosure practices have yet to be analyzed. Finally, many criticisms are based on subjective benchmarks that are difficult to quantify and open to question. To date, however, accounting researchers have played only a minor role in the debate. Because they are well-versed in such areas as disclosure analysis, capital market tests, and the operation of financial intermediaries and external auditors, these researchers potentially have much to add in this regard.
This study examines associations between measures of stock exchange disclosure and market development at 50 of the member stock exchanges of the World Federation of Exchanges. We focus on stock exchange disclosure systems (rather than actual company disclosures) because this approach links stock exchange policy with desired outcomes related to market development (such as liquidity, trading activity, and market size relative to gross domestic product). We find strong support for the hypothesis that the strength of the disclosure system (disclosure rules, monitoring, and enforcement) is positively associated with market development, after controlling for legal system, legal protection of investors, market size, and several other potentially relevant explanatory variables. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2006.
We analyze credit watch and rating actions to better understand the role of credit watches in the credit rating process. We find that watch actions are more frequently prompted by specific, publicly known events than are rating actions. The likelihood that a watch action precedes a rating action varies systematically with proxies for investor demand for credit quality information and the adverse consequences of issuing a rating change prematurely. Credit watches occur more often in response to deterioration in credit quality, and issuers make concerted efforts to address the concerns that prompted down watches. Down watches are less likely than up watches to indicate the direction of the subsequent rating change. Watch announcements are associated with abnormal stock returns, indicating that credit watch actions are significant information events. Our results suggest that credit watches are informative and facilitate the stability of ratings by allowing firms to correct deficiencies and prevent downgrades.
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