Corporate Governance and Rating: Do Agencies Rate Mutual Bank Bonds Fairly?

Abstract

We investigate whether rating agencies calibrate the rating of bonds issued by cooperative banks and stock banks to the true risk of insolvency of the issues. Agency theoretic arguments suggest that cooperative banks are subject to incentives to hold asset portfolios of lower risk than a stock bank. This difference should be reflected, on average, in a higher quality rating for cooperative banks bonds over stock banks bonds. To perform the empirical analysis we use as benchmark of ex-ante market wide estimate of insolvency risk, the yield spread required by the investors on bonds of both types of institutions. The hypothesis is that if investors require a lower insolvency risk premia on bonds, this should be reflected in a higher-quality rating. Alternatively, if investors require systematically a lower premia on cooperative bank bond issues than comparable issues of comparable stock banks after controlling for the rating, this means that investors perceive that the institution presents a lower insolvency risk than that implied by the rating. We use 106 pairs of a matched samples of cooperative and stock banks to perform the analysis. The results obtained are that, after controlling for other sources of variation in the risk premia (including rating), investors charge a lower and statistically significant spread on cooperative banks than on stock banks. However, rating agencies make no difference in the rating and thus ignoring the ex-ante lower insolvency risk in their assessment. Further, results suggest that rating agencies may not have a clear model for rating CB bonds consistently. This findings agree with similar results in the literature that find that rating agencies display a bias toward known management styles and favor (commercial) banks over other (industrial) type of enterprises.