Crisis and Competition in Expert Organizational Decision Making: Credit-Rating Agencies and Their Response to Turbulence in Emerging Economies

Abstract

F irms often delegate elements of strategic decisions to outside experts who promise objective assessments, which are especially valuable in unstable environments. However experts themselves may be prone to skewed decision making as the stability of their own industry environment changes and as their positioning within the industry shifts. We examine this possibility in the context of expert credit-rating agencies ("agencies") and their risk ratings of emerging-market sovereign borrowers ("ratings") published from 1987 to 1998, a period that includes both industry stability (1987-1996) and industry turbulence set off by financial crises in several emerging-market countries (1997-1998). After controlling for macroeconomic and related objective risk factors linked to the sovereigns themselves, we find several points: (1) agency ratings during crisis-induced industry turbulence are negatively skewed, indicating undue pessimism among these experts, in line with decision-making perspectives predicting negative reaction by experts in an effort to retain legitimacy with salient stakeholders, in this case, investors and public regulators; (2) this negative shift is greater for incumbent firms and regionally focused firms, possibly because of the loss of previous informational advantages; and (3) this negative shift during crisis-induced turbulence is greater as industry rivalry among these experts increases in particular market segments, possibly indicating the development of competitive bandwagons among experts. Together, our results suggest that objective assessments by expert organizations are vulnerable to substantial distortion from the confluent effects of industry instability and expert positioning within the industry, particularly positioning affecting rivalry among experts. Ironically, experts may be most likely to mislead clients in unstable industry environments when experts command greater attention and should show greater fidelity to disinterested objectivity.

Elections, Opportunism, Partisanship and Sovereign Ratings in Developing Countries

“…Agency assessments of sovereign risk are generally presumed to be less favorable with left-wing incumbents since their policy preferences, which tolerate higher inflation, are less investor-friendly and increase the likelihood of default. Recent empirical studies on macroeconomic determinants of agency ratings by Cantor andPacker (1996a, 1996b), Larraín et al (1997), McNamara and Vaaler (2000), and Vaaler and McNamara (2004), yield results consistent with this view. They all find that inflation is negatively related to agency ratings for industrialized (Cantor andPacker, 1996a, 1996b;Larraín et al, 1997) and developing countries (McNamara and Vaaler, 2000;Vaaler and McNamara, 2004 More refined treatment of agency electoral expectations permits us to integrate opportunistic and partisan PBC considerations into a broader conceptual framework and related hypotheses about election-year changes in agency ratings.…”

“…Recent empirical studies on macroeconomic determinants of agency ratings by Cantor andPacker (1996a, 1996b), Larraín et al (1997), McNamara and Vaaler (2000), and Vaaler and McNamara (2004), yield results consistent with this view. They all find that inflation is negatively related to agency ratings for industrialized (Cantor andPacker, 1996a, 1996b;Larraín et al, 1997) and developing countries (McNamara and Vaaler, 2000;Vaaler and McNamara, 2004 More refined treatment of agency electoral expectations permits us to integrate opportunistic and partisan PBC considerations into a broader conceptual framework and related hypotheses about election-year changes in agency ratings. Frey and Schneider (1978) and Franzese (2002) suggest that opportunistic incentives may be modified by the incumbent's likelihood of victory as election day approaches.…”

How Do MNCS Vote in Developing Country Elections?

“…I omit the last year of observation, 2000, and include 13 0 -1 year dummies for the other years. Next, I include 15 macroeconomic and related country control variables (macroeconomic factors) that previous researchers have used to explain the broader attractiveness of countries for lending, investment, and economic development (Cantor & Packer, 1996;Humphreys & Bates, 2005;La Porta et al, 1998;Vaaler & McNamara, 2004;Vaaler et al, 2006). The data on these variables are updated on an approximately annual basis; thus, final data on each of the 15 terms may not be available in each year t in which MNCs make investment project decisions.…”

“…Thus, in the first year, if there is a 20 percent depreciation, then the country is in currency crisis. In the next year, depreciation must increase to at least 22 percent to continue in currency crisis (Vaaler & McNamara, 2004).…”

Project valuation in the presence of loss aversion during economic crises

“…Th is is explained by the lower market valuation of new projects, either because expectations decrease or because the discount rate increases to account for revised perceptions of risks (Rivers and Arvai, 2007). Th e expectations could be lowered either because the future projections are anchored in the present, which in turn is low owing to the crisis, or because the crisis generates pessimism (Vaaler and McNamara, 2004;Ashta, 2007;Bruner and Carr, 2007) and future expectations are clouded. Normally, in a depression, central banks are expected to reduce interest rates (Flannery, 1996), and often do so (Chang, 2009;Johansson, 2009).…”