Spillover Effects of Reputational Shocks in the Credit Rating Industry:Earnings Management Perspective
LIN Wanfa, XIA Xiaohan, ZHONG Huiyong
School of Economics and Management, Wuhan University;
Antai College of Economics&Management, Shanghai Jiao Tong University,Shanghai Institute for National Economy
Summary:
In November 2020, the defaults of AAA bonds issued by two state-owned enterprises (SOEs), Brilliance Automotive and Henan Yong Coal Group, broke the ‘rigidity' of AAA-rated SOE bonds. The default of highly rated bonds not only harms the issuing enterprises, but also may have a negative spillover effect on the industry and regional bond issuance.Defaults on high-grade bonds have led to a negative impact on the reputation of the rating industry, which will inevitably affect investors' trust in the rating results. For issuers, a direct effect of the negative impact is that, as investors doubt the credibility of the rating industry, when the credibility of external rating information decreases, investors will rely more on internal information to make decisions and will pay more attention to changes in corporate solvency. Therefore, once the reputation of the credit rating industry is negatively impacted, enterprises with ratings will also be further scrutinized by investors, which in turn will affect their financing costs and choice of financing channels. In the face of these adverse effects, will rated firms take relevant measures to reduce the negative impact of the rating industry's reputation shock on their firms？ This paper defines the behavioral change of rated enterprises as the “spillover effect of the reputation shock of credit rating industry”.In terms of the economic consequences of the rating industry's reputational shock, we focus on firms' earnings management behavior. Specifically, this paper constructs a DID model using the Dagong Global penalty event as a natural experiment of the rating industry reputation shock, and selects the quarterly data of A-share listed companies from 2017-2019 as the research sample to examine the post-shock changes in the level of earnings management of rated firms in response to the negative shock to the reputation of the rating industry. The empirical results find that, firstly, the earnings management activities of rated firms increase significantly after the Dagong Global penalty event, and the conclusion still holds after a series of robustness tests. At the same time, the increase in the level of earnings management is mainly shown as a short-term effect due to the pressure of earnings management costs. Secondly, the cross-sectional analysis shows that the positive relationship between rating reputation shocks and earnings management is more significant in the group where firms have large ex-ante financing constraints. Thirdly, this paper also finds that when the rating industry reputation is negatively impacted, firms obtain more bank and bond market credit resources by engaging in more earnings management, while their engagement is also exposed to the risk of deteriorating future performance and increased risk. Finally, the negative impact on the rating industry's reputation caused by the punishment of Dagong Global has also led to an improvement in the quality of ratings in the credit rating industry.The research contribution of this paper is threefold: First, existing research has extensively analyzed the functions of credit ratings, such as the fact that changes in credit ratings convey valuable information to the market. For the first time, this paper uses the exogenous event of the punishment of Dagong Global to test how the negative impact on the reputation of the rating industry affects firms' financial decision-making. Second, previous studies have mainly analyzed the influencing factors of earnings management from the perspectives of government regulation, listed company performance appraisal, corporate governance, minimum wage level, and small-and medium-sized shareholders' behaviors, and this paper focuses on analyzing the impact of the negative impact of the reputation of the credit rating industry on the firms' earnings management behavior, therefore enriches the literature on the influence factors of surplus management from the bond market perspective. Third, there aren't many assessments of the effects of regulatory policies in the bond market, and some of the existing studies have focused on qualitative discussions of issues in the reform of the regulatory system, emphasizing that the current regulatory fragmentation is not conducive to the development of the bond market. This paper also provides evidence for the empirical assessment of the effectiveness of bond market regulatory policies, especially rating industry policies, in the bond market.With the high level of opening up of the credit rating market to the outside world, foreign rating agencies enter China. Future research could specifically analyze the improvement in the quality of ratings made by local rating agencies with the entry of foreign rating agencies.
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