Three essays on credit ratings

Abstract

This dissertation consists of three essays on credit ratings. The first essay examines the spillover effects that occur within Korean business groups (i.e., chaebols) by focusing on the market reactions of event firms to announcements of credit rating changes. We find that there are positive spillovers (caused by positive market reactions) and negative spillovers (caused by negative market reactions) that are driven by the market reactions of event firms. Our analyses indicate that negative spillovers are more dominant than positive spillovers. Moreover, a spillover that is driven by a leading firm within a business group has stronger effects on other firms in the group than a spillover that is driven by a non-leading firm. This suggests that the market evaluation of a business group is conducted more on the basis of a leading firm than a non-leading firm within a group. Finally, we show that the spillover effects that are analyzed in our study are more noticeable when the business relationship between an event firm and other affiliated firms is closer. The second essay shows the extent to which credit ratings affect firms’ cash holdings by investigating the circumstances in Korea after the 1997 Asian financial crisis. We find that credit ratings are a major consideration for corporate cash management because of the costs and benefits associated with different rating levels. Specifically, firms that become relatively sensitive to rating changes increase their cash holdings, either to improve the chances of an upgrade or to avoid a downgrade. Further, this effect is driven by chaebol business groups, which rely increasingly on external financing that depends on credit ratings following the attenuation of their internal capital markets. Finally, we show that the impact of credit ratings on firms’ cash holdings is more noticeable when firms are more prominent in the market. The third essay investigates whether foreign equity participation fostered the growth of Korea’s credit rating industry during the 2002？2013 period. We find that the rating quality deteriorated steadily even though the foreign ownership of Korea’s credit rating agencies increased: Rating levels went up. Our analysis indicates that the Korean government’s policy of gradually relaxing the restrictions on foreign ownership of local credit rating agencies was ineffectual.