Product Market Competition and Credit Ratings

This study examines which of the two conflicting effects of rated firms' product market competition their credit ratings reflect: the disciplining effect or the risk-increasing effect. After controlling for firm-specific risk characteristics and macro-economic conditions, we find that firms in competitive industries obtain higher credit ratings than do those in less competitive industries, which indicates that the disciplining effects of competition outweigh the risk-increasing effects. The positive relation between competition and credit ratings is stronger for firms with weak corporate governance, suggesting a substitutive relation between competition and corporate governance for this group. We show that mitigation of agency problems, such as over- or under-investment and financial misreporting, is a potential explanation for the positive relation between product market competition and credit ratings.
Introduction Credit ratings reflect a rating agency's forward-looking summary opinions of the creditworthiness of a particular company or debt security. These opinions, expressed in an ordinal rank code, play an [...]