Topic: Credit Rating Inflation and Firms’ Investments
Speaker: Chong Huang, Assistant Professor in Finance, University of California, Irvine
Date: April 11 (Wednesday)
Location: Building 4, Room 101
We analyze credit ratings' effects on firms' investments in a rational debt-rollover game that features a feedback loop. The credit rating agency (CRA) has an inherent incentive to inflate the rating, providing a biased but informative signal to investors. Investors' response to the rating affects the firm's cost of capital, investment decision, and credit quality, and this is reflected in the initial rating. The CRA might reduce ex-ante economic efficiency, and this comes solely as a result of the feedback effect of the rating: The CRA understands the effect of the information it provides and allows more firms to gamble for resurrection. We derive empirical predictions on the determinants of rating standards and rating inflation, and discuss policy that could potentially avoid the inefficiency.
About the speaker:
Chong Huang joined The Paul Merage School of Business in July 2012 as an Assistant Professor of Finance. His research interests include learning in financial markets, corporate finance, and financial crises. Before joining The Merage School, Professor Huang received his PhD degree in Economics from the University of Pennsylvania. He received a Bachelor degree in Finance from Peking University and a Master’s degree in Economics from the Chinese University of Hong Kong.