Do S&P's Corporate Ratings Reflect Credit Shocks?

This study examines empirically whether corporate ratings by the credit ratingagency Standard & Poor’s reflect fundamental and publicly observable shocks tothe credit quality of companies. This serves to assess the degree of informationsensitivity of external ratings, and the timeliness of their adjustments.Our evidence on a large sample of European companies from 2000-2008 clearlyindicates that external ratings frequently do not reflect fundamental changes in thecredit quality of companies. This lack of information sensitivity seems neither attributableto private information from monitoring nor the rating-through-the-cycleapproach employed by S&P.The intended regulation of rating agencies thus not only needs to validate theprocess of rating generation but needs to define the purpose and desirable characteristicsof ratings in the first place. The proposed methodology in this study,which is based on publicly observable capital market information, can help investorsand regulators to validate external ratings....