Investor-Paid Credit Ratings and Managerial Information Disclosure

Unlike issuer-paid credit rating agencies (CRAs), investor-paid CRAs are compensated by investors for providing rating services. Exploiting the staggered timing of rating initiation by an investor-paid rating agency (the Egan Jones Ratings (EJR)), I document that the coverage by EJR increases rated firm managers’ voluntary disclosure of negative news. Consistent with EJR’s rating coverage deterring managerial bad news hoarding by informing investors of downside risks, I find that the effect of EJR coverage is more pronounced when issuer-paid CRAs tend to assign inflated ratings and when rated firms’ managers have a stronger incentive to conceal bad news. I also document that firms unwind upward earnings management after being covered by EJR. In contrast, coverage by an issuer-paid CRA (Standard & Poor’s) is not associated with changes in managerial information disclosure. I conclude that investor-paid CRAs function as a type of effective information intermediary to discipline firm managers and improve corporate transparency. This paper was accepted by Brian Bushee, accounting. Funding: The author acknowledge financial support from the MOE Project of the Key Research Institute of Humanities and Social Science in University [Grants 22JJD790093 and 22JJD790094], the Program for Innovative Research Team of Shanghai University of Finance and Economics, and the 111 Project [Grant B18033]. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2021.01914 .