Tightening Credit Standards: The Role of Accounting Quality

53 Pages Posted: 4 Oct 2005 Last revised: 10 Jul 2013

See all articles by Philippe Jorion

Philippe Jorion

University of California, Irvine - Paul Merage School of Business

Charles Shi

NUS Business School, National University of Singapore

Sanjian Bill Zhang

California State University Long Beach

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 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) can 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.

Keywords: credit rating agencies, credit standards, accounting quality, earnings management, value-relevance

JEL Classification: G14, G32, M41

Suggested Citation

Jorion, Philippe and Shi, Charles and Zhang, Sanjian, Tightening Credit Standards: The Role of Accounting Quality (August 1, 2007). Review of Accounting Studies, Vol. 14, No. 1, 2009, Available at SSRN: https://ssrn.com/abstract=817168 or http://dx.doi.org/10.2139/ssrn.817168

Philippe Jorion

University of California, Irvine - Paul Merage School of Business ( email )

Campus Drive
Irvine, CA 92697-3125
United States
949-824-5245 (Phone)
949-824-8469 (Fax)

Charles Shi (Contact Author)

NUS Business School, National University of Singapore ( email )

15 Kent Ridge Dr
Singapore, 119245
Singapore
65-65161678 (Phone)

HOME PAGE: http://bschool.nus.edu/Accounting/FacultyStaff/Facultymembers.aspx

Sanjian Zhang

California State University Long Beach ( email )

1250 Bellflower Blvd.
Long Beach, CA 90840
United States

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