Rating Shopping and Rating Inflation: Empirical Evidence from Israel

Inna Bakalyar () and Koresh Galil ()
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Inna Bakalyar: Ben-Gurion University of the Negev, Department of Economics, P.O. Box 65, Beer-Sheva 84105, Israel

No 1102, Working Papers from Ben-Gurion University of the Negev, Department of Economics

Abstract: The collapse of structured bond ratings during the 2007-2008 financial crisis called attention to the possibility of rating inflation due to lowered rating standards and rating shopping. Nevertheless, little empirical evidence has been offered for this prospect. The Israeli corporate credit rating market serves as solid ground for investigating this matter. In this study, we use data on corporate bond ratings assigned by two local rating agencies affiliated with S&P and Moody’s during the period 2004-2009. We show that while one agency (Midroog) systematically assigned higher ratings, the ratings of the other agency (S&P-Maalot) were inflated due to rating shopping. These conclusions are based on several findings: the presence of selection bias in dual ratings, the superior accounting features of firms rated by S&P-Maalot relative to those similarly rated by Midroog, and the greater tendency of single ratings by S&P-Maalot to be downgraded. We confirm the predictions of recent theoretical studies that rating inflation may occur even when the value of the rating agencies derives from their reputation.

Pages: 38 pages
Date: 2011
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