Are rating actions timely? An analysis of the determinants of the timing of rating actions from an international prospective

Rating agencies face widespread criticism regarding the quality and timing of their opinions (i.e. credit ratings) especially after a crisis. Notwithstanding such widespread blame, rating agencies still play a crucial role in the financial markets. For example, credit ratings have a huge impact on credit spread, on firm returns and on financial institutions’ regulation that is tied to credit ratings. Ratings tend to be relatively stable over time. However, significant and unanticipated changes in the general conditions of the economy or the individual issuer will result in a rating review. Raters can issue a “watch”, which notifies investors that there is a reasonable probability of a rating change and the likely direction of such change (positive or negative). There two potential measures of the rating action timing: i) the time between the occurrence of new information and the issue of a credit watch, and ii) the time between a credit watch and a rating change. A “wrong” rating is essentially a rating that is not changed in a timely fashion. This is the most typical criticism addressed to ratings agencies, which, under certain circumstances, did not promptly downgrade issuers that then turned out to be insolvent (over-rating). Similarly, a rater might not upgrade an issuer despite its characteristics justify a better rating (under-rating). While it is true that the agencies’ approach always results in some delay between the emergence of the causes of a rating change and the change itself, it is unclear which factors explain such delay both in the cross-section and over time. Despite the importance of the timing of rating actions, this topic has received little attention by the literature. This project aims to fill this gap by addressing the following research questions:• Is the timing of both rating actions affected by issuer-specific and country-specific characteristics or by the length of the relationship between rater and issuer? • Does the timing of rating actions depend on the rating agency and the market structure? Is it affected by macro or financial market conditions? Our study will make several contributions to the literature because, to the best of our knowledge, it is the first to examine the timing of rating actions. Our analysis will provide empirical evidence that improves the understanding of the role of credit watches in the credit rating process and it will considerably help to shed light on whether credit watches increase default prediction accuracy and convey information to market participants. This is increasingly important because CRAs provide minimal information about their credit watch procedures. Furthermore, the understanding of the timeliness of rating action will improve the market perception of CRA’s opinions reliability and will affect investors’ asset allocation. Finally, our findings will have a significant impact on financial regulation that is widely tied to credit ratings (i.e. the Basel Accord).