We test whether bond ratings contain pricing-relevant information by examining security price reactions to Moody's refinement of its rating system, which was not accompanied by any fundamental change in issuers' risks, was not preceded by any announcement, and was carried simultaneously for all bonds. We find that rating information does not affect firm value, but that debt value increases~decreases! and equity value falls~rises! when Moody's announces better-~worse-! thanexpected ratings. We also find that when Moody's announces better-~worse-! thanexpected ratings, the volatilities implied by prices of options on the fine-rated issuers' shares decline~rise!. VIRTUALLY ALL LARGE CORPORATE BOND ISSUES are rated by at least one rating agency. These ratings are costly: $25,000 for issues of up to $500 million and half a basis point of the issued amount for issues exceeding $500 million. Interestingly, although bonds are rated whether the issuer pays for the rating or not, about 98 percent of the issuers choose to pay to have their bonds rated.Why do corporations pay for ratings? Perhaps to gain better ratings. However, this is inconsistent with raters' income being so crucially dependent on their reputation. Alternatively, paying for ratings may allow firms to incorporate inside information into the assigned ratings without disclosing specific details to the public at large. Publicly revealing inside information might benefit competitors or subject insiders to lawsuits should the projections not materialize, whereas rating agencies can incorporate privately disclosed information into the ratings that they assign without fully revealing it. Indeed, during the rating process, corporations provide raters with detailed inside information~e.g., five-year forecasts and pro-forma statements, internal reports!. 1 , the editor, Menahem Spiegel, Franco Wong, and seminar participants at the Hebrew University, NYU, Tel Aviv University, University of Haifa, University of Michigan, and the Wharton School for helpful comments and suggestions. Kliger thanks the Fulbright Foundation and the Israel Foundation Trustees for partial financial support.1 Initially, issuers did not pay for ratings; only investors did. Under this arrangement, as rating information was quickly incorporated into bond prices, nonpaying investors were able to free ride the rating process~cf.
