The Information Value of Credit Rating Reports

We test if Standard & Poor's (S&P) credit rating reports contain valuable information beyond credit ratings. We find that positive (negative) linguistic tone in the reports are significantly related to positive (negative) abnormal returns at the time of downgrade announcement and the tone can predict future rating downgrades. We discover that the provision of tone is more consistent with the building of reputation by S&P rather than pleasing the rated firms. Investors, however, are overly concerned about the conflict of interest faced by S&P as a result of an issuer-paid business model. Overall, our study reveals important information value of credit rating reports, which have attracted more attention from regulators than academics.