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| Tightening Credit Standards: The Role of Accounting Quality by Philippe Jorion of the University of California at Irvine, March 2007 Abstract: Over the latest twenty years, the average credit rating of U.S. corporations has trended down. This observation has been interpreted as evidence that rating agencies have been tightening credit standards. More formally, Blume, Lim, and MacKinlay (1998) model the credit rating process by an ordered probit regression and indeed find that the annual intercept, reflecting the average credit rating, has been drifting down, holding the effect of other variables constant. We reexamine the causes of the observed decreases in average credit ratings in several ways. First, we show that this downward trend does not apply to speculative-grade issuers. Second, our analysis of structural shifts in investment-grade issuers reveals that the apparent tightening of standards reported by Blume et al. (1998) cab be attributed primarily to changes in accounting quality over time. Specifically, we find that the value-relevance of commonly used accounting ratios to creditors decreased and that earnings management increased for investment-grade firms, but not for speculative-grade firms. After incorporating changes in accounting quality into the credit ratings analysis, we find no evidence that rating agencies have tightened their credit standards. Our findings underscore the critical role of accounting quality in the credit ratings analysis. JEL Classification: G14, G32, M41. Keywords: credit rating agencies, credit standards, accounting quality, earnings management, value-relevance. Previously titled: Tightening Credit Standards: Fact or Fiction? |   
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