The Economics of Rating Watchlists:Evidence from Rating Changes

Generally, information provision and certi¯cation have been identi¯ed as the majoreconomic functions of rating agencies. This paper analyzes whether the \watchlist"(rating review) instrument has extended the agencies' role towards a monitoringposition, as proposed by Boot, Milbourn, and Schmeits (2006). Using a data set ofMoody's ratings between 1982 and 2004, we ¯nd that the overall information con-tent of rating action has indeed increased due to the introduction of the watchlistprocedure. Our ¯ndings suggest that rating reviews help to establish implicit moni-toring contracts between agencies and borrowers and as such enable a ¯ner partitionof rating information, thereby contributing to a higher information quality.