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Unintended Consequences of the Dodd–Frank Act on Credit Rating Risk and Corporate Finance

Published online by Cambridge University Press:  17 January 2022

Bina Sharma ,
Binay K. Adhikari ,
Anup Agrawal Open the ORCID record for Anup Agrawal [Opens in a new window] ,
Bruno R. Arthur  and
Monika K. Rabarison
Bina Sharma
Affiliation:
Bellevue University College of Business [email protected]
Binay K. Adhikari
Affiliation:
University of Texas at San Antonio Alvarez College of Business [email protected]
Anup Agrawal*
Affiliation:
University of Alabama Culverhouse College of Business
Bruno R. Arthur
Affiliation:
University of Texas at Rio Grande Valley Vackar College of Business and Entrepreneurship [email protected]
Monika K. Rabarison
Affiliation:
University of Texas at Rio Grande Valley Vackar College of Business and Entrepreneurship [email protected]
*
[email protected] (corresponding author)
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Abstract

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Prior research finds that Dodd–Frank Act’s regulations on credit rating agencies (CRAs) increase rated firms’ risk of rating downgrades, regardless of their credit quality. Our difference-in-difference estimates suggest that after Dodd–Frank, low-rated firms, which face steep costs from a further downgrade, significantly reduce their debt issuance and investments compared to similar unrated firms. Our results are not driven by credit supply or the financial crisis. They reveal an unintended consequence of Dodd–Frank: Greater regulatory pressure on CRAs leads to negative spillover effects on firms concerned about credit ratings, regardless of their credit quality.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 6 , September 2022 , pp. 2286 - 2323
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank Mehran Azimi, Alex Butler, David Cicero, Soroush Ghazi, Incheol Kim, Sandy Klasa, Lei Kong, Mina Lee, and conference and seminar participants at the FIRS-Savannah and the Universities of Alabama, New Orleans, and Texas Rio Grande Valley for useful comments. Special thanks are due to an anonymous referee and to Jarrad Harford (the editor) for helpful suggestions. Agrawal acknowledges research support from the William A. Powell, Jr. Chair in Finance and Banking. Earlier drafts of the article were called “Dodd–Frank Act, Credit Rating Agencies and Corporate Financing and Investment Decisions.”

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