Rating Friends: The Effect of Personal Connections on Credit Ratings
In their paper “Rating Friends: The Effect of Personal Connections on Credit Ratings” Hossein Khatami, professor of finance at Hult, Maria-Teresa Marchica, and Roberto Mura, investigate the impartiality and independence of credit issuing companies and credit rating agencies in the U.S.
In their study, they found that personal connection between directors of these companies may impact the quality of credit ratings in several ways.
The paper was published in The Journal of Corporate Finance and you can read the paper in full here.
Khatami, S. H., Marchica, M., & Mura, R. (2016). Rating Friends: The Effect of Personal Connections on Credit Ratings. Journal of Corporate Finance.
Using a large sample of U.S. public debt issues we show that personal connections between directors of issuing companies and rating agencies result in higher credit ratings. We estimate the average effect to be about one notch. Moreover, our tests indicate that issues by connected firms are 30% more likely to be rated A3. Results are robust to several alternative tests including additional controls for managerial traits, firm fixed effects, and propensity score matching. Furthermore, our tests on default rates and bond yields suggest that personal connections act as a mechanism to reduce asymmetric information between the rating agency and the issuer.
• We report that ceteris paribus, issues by connected firms receive higher ratings
• The average difference in rating between issues by connected and unconnected firms is about one notch
• The higher ratings of connected companies are not due to favorable treatment but they reflect lower asymmetric information
Hossein Khatami has been a Professor of Finance at Hult since September 2013. Hossein worked as an investment consultant and financial analyst before doing his Masters at Cass Business School. He completed his PhD at Manchester Business School in a research network with partners including McKinsey & Co., Credit Suisse, MSCI, and KPMG, among others . He then went back to his home country of Iran to enjoy one of the most educational experiences of his life: establishing an asset management and investment banking division for a leading bank in the region. He was involved all aspects of the business from product design and development to trading and portfolio management, from sales and negotiations to people management and strategic planning, and the division grew fast to become a major contributor to the bank’s profitability. He has also established and now manages two companies with primary focus on asset management and business consulting.
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