Open Access

In this paper, we propose a model of credit rating agencies using the global games framework to incorporate information and coordination problems. We introduce a refined utility function of a credit rating agency that, additional to reputation maximization, also embeds aspects of competition and feedback effects of the rating on the rated firms. Apart from hinting at explanations for several hypotheses with regard to agencies' optimal rating assessments, our model suggests that the existence of rating agencies may decrease the incidence of multiple equilibria. If investors have discretionary power over the precision of their private information, we can prove that public rating announcements and private information collection are complements rather than substitutes in order to secure uniqueness of equilibrium. In this respect, rating agencies may spark off a virtuous circle that increases the efficiency of the market outcome.

Generally, information provision and certifcation have been identified as the major economic functions of rating agencies. This paper analyzes whether the “watchlist” (rating review) instrument has extended the agencies' role towards a monitoring position, as proposed by Boot, Milbourn, and Schmeits (2006). Using a data set of Moody's rating history between 1982 and 2004, we find that the overall information content of rating action has indeed increased since the introduction of the watchlist procedure. Our findings suggest that rating reviews help to establish implicit monitoring contracts between agencies and borrowers and as such enable a finer partition of rating information, thereby contributing to a higher information quality.

Financial markets are to a very large extent influenced by the advent of information. Such disclosures, however, do not only contain information about fundamentals underlying the markets, but they also serve as a focal point for the beliefs of market participants. This dual role of information gains further importance for explaining the development of asset valuations when taking into account that information may be perceived individually (private information), or may be commonly shared by all traders (public information). This study investigates into the recently developed theoretical structures explaining the operating mechanism of the two types of information and emphasizes the empirical testability and differentiation between the role of private and public information. Concluding from a survey of experimental studies and own econometric analyses, it is argued that most often public information dominates private information. This finding justifies central bankers´ unease when disseminating news to the markets and argues against the recent trend of demanding full transparency both for financial institutions and financial markets themselves.

Small and medium-sized firms typically obtain capital via bank financing. They often rely on a mixture of relationship and arm’s-length banking. This paper explores the reasons for the dominance of heterogeneous multiple banking systems. We show that the incidence of inefficient credit termination and subsequent firm liquidation is contingent on the borrower’s quality and on the relationship bank’s information precision. Generally, heterogeneous multiple banking leads to fewer inefficient credit decisions than monopoly relationship lending or homogeneous multiple banking, provided that the relationship bank’s fraction of total firm debt is not too large.

We examine firms’ simultaneous choice of investment, debt financing and liquidity in a large sample of US corporates between 1980 and 2014. We partition the sample according to the firms’ financial constraints and their needs to hedge against future shortfalls in operating income. In contrast to earlier work, our joint estimation approach shows that cash flows affect the corporate decisions of unconstrained firms more strongly than those of constrained firms. Investment-cash flow sensitivities are particularly intense for unconstrained firms with high hedging needs. Investment opportunities (as proxied by Q), however, play a larger role for constrained firms with the effects being strongest in case of low hedging needs. Interestingly, constrained firms with low hedging needs are found to employ more debt to finance their investment opportunities and build up significant cash holdings at the same time. Our results hence indicate overinvestment behavior for unconstrained firms but no underinvestment for constrained firms if they have low hedging needs.