Abstract
Holding firm fundamentals constant, credit ratings of the Chinese firms have increased by one notch on average during 2009-2017. The rating standard relaxation coincides with rating inflation, as the feedback effects of higher ratings that help reduce financing cost and improve investment and future credit quality can only explain a small portion of the rating hikes. Aided by partially reduced debt costs, the more inflated firms have higher leverage, hold less cash, and invest more in capital assets but not research and development. They exhibit moderately higher risk but no improvements to growth, profitability and efficiency. Regulatory arbitrage and conflict of interest rooted in the issuer-pays business model play prominent roles in explaining the rating inflation.
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