Tightened standards or business as usual? : a study of European corporate credit rating cyclicality

Abstract

This paper examines which variables are statistically signi cant in a corporate credit rating process, and if there has been a tightening in rating practice during and after the nancial crisis hit Europe in 2008. We investigate whether we can argue that the possible tightening of standards can be seen as a procyclical way of assessing credit ratings. By procyclical ratings we refer to CRAs' tendency to excessive downgrade in recession, leading to higher capital cost for the downgraded companies, thus leading to even poorer results and an intensi ed recession. Utilizing annual fundamental values from rms in the Eurozone and the UK from 2004- 2012 with a Moody's rating, we nd indications for such a tightening of standards, but the evidence is not strong enough to draw any rigid conclusions. All our di erent models over predict post-crisis ratings, with signi cant di erence of means. Further we nd a general downgrading post-crisis of approximately 0.75, where a value of 1 equals one subrank rating, adjusted for the e ects from corporate fundamental variables. Breaking it down into cross-section analysis, we nd strong evidence that some industries and regions may have experienced stricter standards than others. Our analysis is based on two di erent methods; (1) building models based on pre-crisis data using corporate nancials and macroeconomic variables to compare an out-of- sample estimation with the actual post-crisis ratings, and (2) using propensity score matching also using corporate nancials.