The Effects of Formal and Informal Institutions on the Credit Ratings of Foreign Firms Cross-Listed in the U.S. Market

This study investigates the role of formal and informal institutions in the credit ratings of foreign firms cross-listed in the U.S. listing market. The U.S. regulatory environment and national culture are employed to capture formal and informal institutions, respectively. To the extent these institutional influences could affect firms' default risks and agency costs, credit analysts are expected to adjust corporate ratings accordingly. First, I find that the credit ratings of cross-listed firms are significantly lower than those of comparable U.S.-domiciled firms. The evidence reflects that cross-listed firms do not face exactly the same regulatory stringencies as U.S. domestic firms, which may reduce the credibility of cross-listed firms. Credit analysts, therefore, may find the accounting information of cross-listed firms less informative or credible to formulate ratings. Thus, they perceive an increase in default risks and agency costs resulted from the information asymmetry between cross-listed firms and external stakeholders. Next, using Schwartz's two cultural dimensions (embeddedness and mastery) as proxies for culture, I document robust evidence of higher credit ratings of cross-listed firms domiciled in high-embeddedness or strong-mastery countries. This finding reveals that credit analysts recognize the cultural power in moderating the negative impacts induced by the SEC's lax enforcement on cross-listed firms. Specifically, it is consistent with cultural effects that influence managers' behaviours and decisions, and then restrain managers from investing in high default-risk projects. My study contributes to the credit rating and culture literature by showing that credit analysts consider both formal and informal institutional factors in firms' agency costs and default risks. This evidence further implies that cross-listed firms and U.S.-domiciled firms are not regulated on a level playing field in a one-size-fits-all legal environment in the eyes of credit analysts. However, culture helps moderate the different regulatory enforcements between cross-listed firms and U.S. firms.