CEO political ideology and credit risk assessment

Abstract

PurposeThe authors examine the role of CEO political ideology in the credit rating process.Design/methodology/approachThis study adopts a quantitative method with panel data regressions using a sample of 5,211 observations from S&P 500 firms from 2001 to 2012.FindingsThe authors find that firms run by Republican-leaning CEOs, who tend to have conservative political ideologies, enjoy more favorable credit ratings than firms run by Democratic-leaning CEOs. In addition, the association between CEO political ideology and credit ratings is more pronounced for firms with high operating uncertainty, low capital intensity, high growth potential, weak corporate governance and low financial reporting quality. Finally, the authors find that CEO political ideology affects a firm's cost of debt incremental to credit ratings, consistent with debt investors incorporating CEO political ideology in their pricing decisions.Research limitations/implicationsLeveraging CEO political ideology, the authors document that credit rating agencies incorporate managerial conservatism in their credit rating decisions. This finding suggests that CEO political ideology serves as a meaningful signal for managerial conservatism.Practical implicationsThe study suggests that credit rating agencies incorporate CEO political ideology in their credit rating process. Other capital market participants such as auditors and retail investors can also use CEO political ideology as a proxy for managerial conservatism when evaluating firms.Social implicationsThe paper carries practical implications for practitioners, firm executives and regulators. The results on the association between CEO political ideology and credit ratings suggest that other financial institutions could also incorporate CEO political ideology in their evaluation in their evaluation of firms. For example, when evaluating audit risk and determining audit pricing, auditors may add CEO political ideology as a risk factor. For firms, especially those that have Democratic-leaning CEOs, the authors suggest that they could reduce the unfavorable effect of CEO political ideology on credit ratings by improving their corporate governance and financial reporting quality, as demonstrated in the cross-sectional analyses. Finally, this study shows that CEO political ideology, as measured by CEOs' political contributions, is closely related to a firm's credit ratings. This finding may inform regulators that greater transparency for CEOs' political contributions is needed as information on contributions could help capital market participants perform risk analyses for firms.Originality/valueCredit rating agencies release their research methodologies for determining corporate credit ratings and identify managerial conservatism as an important factor that affects their risk assessments. The extant literature, however, has not empirically investigated the relation between credit ratings and managerial conservatism, which, according to behavioral consistency theory, can be proxied by CEO political ideology. This study provides novel empirical evidence that identifies CEO political ideology as an important input factor in the credit rating process.