The Effect of the Credibility of Mandatory Disclosure by Credit Rating Agencies on Managerial Learning from Stock Prices

Using the Credit Rating Agency Reform Act of 2006, we examine the credibility of mandatory disclosure by credit rating agencies (CRAs) on managerial learning from stock prices. We find an increase in investment-price sensitivity for firms affected by the Act. Consistent with managers relying more on stock prices in making investment decisions in the post-CRARA period, the increase is more marked when managers have greater incentives to glean information from prices—when firms are exposed to multiple dimensions of uncertainty, have higher growth options, face steeper competition, have less informed managers, and have higher accounting fraud risk. Future profitability improves, suggesting that managers’ reliance on stock prices improves investment efficiency. Our findings suggest that the greater credibility of CRA mandatory disclosure leads to an increase in investment-price sensitivity by improving the informativeness of stock prices for managers, which facilitates managerial learning from stock prices