Narrow Results

The purpose of this paper is to inform investors of differences in opportunistic behavior between managers of BBB- and BB-graded firms as measured by earnings management and accounting conservatism. Previous studies investigate the gaps between grades and between investment and speculative grades by grouping together the various characteristics of investment and speculative firms, assuming that the incentives to make significant economic changes are homogeneously the same. However, this study demonstrates that this is not the case. Using 1,225 Korean firm-year observations, we identify noteworthy features distinguishing BBB- and BB-graded firms. More specifically, in BBB-graded firms, discretionary accruals (DACC) (a proxy used to represent earnings management) are larger than those in BB-graded firms. As for accounting conservatism, BB-graded firms exhibit a higher degree of conservatism than BBB-graded firms. According to the conventional credit rating scenario, higher-graded firms have fewer DACC and are more conservative in comparison with firms of lower grades. However, the results of this study imply that the reverse is true for firms of grades BBB and BB, which are commonly accepted as straddling the border between investment and speculative grades.

US product-liability laws unwisely treat credit-rating organizations (CROs) as if they produce opinions rather than empirically-based economic research. In principle, trained professionals gather time-varying information ("financial news") and analyze it statistically to reduce it to a single dimension, allegedly for the benefit of investors, which, in turn, enables issuers to finance themselves at lower cost. In practice, the issuer-pays business model currently used for funding the production and distribution of ratings information creates an incentive to favor high-volume issuers by over-rating private-label securitizations. While the Dodd–Frank Act intensifies SEC oversight of CRO activity, the SEC has a history of being captured by regulatory clients. We argue that the fundamental solution is to create accountability in the ratings process so that private label securitizations can play a constructive role in the provision of credit and we go on to offer some conjectures about how this could be done.

The uncertainty about the US debt ceiling and the depreciation of the US dollar versus other major currencies raises the prospect of future currency turmoil – something that may spell the beginning of the end of the US dollar’s uncontested reign, albeit not its role as the most important international currency. A worst-case scenario is an economic crisis with a dramatic fall in global economic growth. US lawmakers seem oblivious to the task they face: Redress the strong imbalances haunting the US economy and manage the decline of the international role of the US dollar. So, is the Federal Reserve System mapping out a monetary policy disregarding the US dollar’s global role?

How does the sovereign credit ratings history provided by independent ratings agencies affect domestic financial sector development and international capital inflows to emerging countries? We address this question utilizing a comprehensive dataset of sovereign credit ratings from Standard and Poor’s from 1995–2003 for a cross-section of 51 emerging markets. Within a panel data estimation framework, we examine financial sector development and the influence of sovereign credit ratings provision, controlling for various economic and corporate governance factors identified in the financial development literature. We find strong evidence that our sovereign credit rating measures do affect financial intermediary sector developments and capital flows. We find that: (i) long-term foreign currency sovereign credit ratings are important for encouraging financial intermediary development and for attracting capital flows; (ii) Long-term local currency ratings stimulate domestic market growth but discourage international capital flows; (iii) Short-term ratings (both foreign and local currency denominated) retard all forms of financial developments and capital flows. There are important implications in this research for policy makers to encourage the provision of longer-term credit ratings to promote financial development in emerging economies.

Asymmetric information associated with issues of transparency, governance and the country’s financial, economic and political organization make it difficult to price bonds issued by sovereign entities. Where asymmetric information and corporate debt are concerned, the literature suggests that factors such as ratings, listing exchange, issuer type, lead manager, number of dealers and influential dealer provide help to mitigate the problem. In this chapter we test whether any of these factors are relevant for Indian Eurobond prices over the period 1990–1992. We find that they do not provide much help. After accounting for changes in the risk-free term structure, none of these factors contributes to explaining secondary market Indian bond prices over the period. Although rating changes are significant, taken together with changes in the risk-free term structure, the adjusted R² is lower than when changes in the risk-free term structure are used alone. None of the other factors are close to being significant at any conventional level.

In this chapter, we shall study bonds and their term structures. Bonds are a major class of investment assets distinct from equities, and they have salient features that will be explained. Continuous time stochastic processes are briefly introduced in this chapter to show their usage in modelling bond prices and therefore the resulting credit spreads and yields. Multiple regression analyses involving explanation of credit spreads and of bond returns are described.