Do Credit Ratings Reflect Private Information about SEC Investigations?

ABSTRACT Despite private access to managers, issuer-paid credit rating agencies (CRAs) are often criticized for failing to promptly reflect material negative private information in their ratings and being ineffective corporate watchdogs. We utilize a novel dataset of private SEC investigations to examine the timeliness and informativeness of CRAs’ rating adjustments in response to material negative private information. Our evidence suggests that CRAs adjust ratings downward within a quarter following the opening of an SEC investigation. Moreover, these adjustments are over three times larger for those investigations that ultimately yield an enforcement action than for those that do not, suggesting that CRAs quickly form sophisticated expectations about the materiality of the private information. Additionally, rating downgrades during the investigations are more informative to the stock market than other rating downgrades. Overall, our evidence suggests that CRAs reduce information asymmetry in the capital markets by timely incorporating material private information in their ratings. Data Availability: All data are available from the sources cited in the text. JEL Classifications: D82; G24; G30; M40; M41.