Ratings Quality and Borrowing Choice

Past studies document that incentive conflicts may lead issuer-paid credit rating agencies to provide optimistically biased ratings. In this paper, we present evidence that investors question the quality of issuer-paid ratings and raise corporate bond yields where the issuer-paid rating is more positive than benchmark investor-paid ratings. We also find that some firms with favorable issuer-paid ratings substitute public bonds with borrowings from informed intermediaries to mitigate the "lemons discount" associated with poor quality ratings. Overall, our results suggest that the quality of issuer-paid ratings has significant effects on borrowing costs and the choice of debt.