Credit ratings, financial ratios, and equity risk: A decomposition analysis based on Moody’s, Standard & Poor’s and Fitch’s ratings

Abstract

This paper applies regression-based methods to analyze the variation in corporate bond ratings within and between credit rating agencies (CRAs). The between-variation is decomposed via the Binder–Oaxaca method, whereas the within-variation is decomposed into three components corresponding to financial ratios, equity risk, and CRA’s private information (residual). In the period from 1995 to 2019, the contribution of equity risk has ascended substantially from 10% to about 30% whereas financial ratios’ importance has declined from 70% to 40%. The gap between Fitch’s ratings and Moodys’/S&P’s was largely due to companies’ endogenous shopping for ratings rather than the difference in rating criteria.