Credit Ratings as Coordination Mechanism

Arnoud Boot and Todd Milbourn

No 3331, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this Paper, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings can serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a ?focal point? for firms and their investors. We explore the vital ? but previously overlooked ? implicit contractual relationship between a credit rating agency and a firm. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of ratings changes, the discreteness in funding cost changes, and the effect of the focus of organizations on the efficacy of credit ratings.

Keywords: Credit ratings; Multiple equilibria; Coordination (search for similar items in EconPapers)
JEL-codes: G23 G24 G32 (search for similar items in EconPapers)
Date: 2002-04
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-rmg
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Citations: View citations in EconPapers (5)

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Journal Article: Credit Ratings as Coordination Mechanisms (2006)
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