Unfamiliarity Breeds Resentment: Familiarity Bias in Inaugural Credit Ratings

Abstract

While a company’s first-time, or inaugural, corporate credit rating should be highly informational, we are concerned that ratings agencies might be impacted by a lack of familiarity with newly rated firms. We examine this issue, finding that ratings agencies issue lower credit ratings for firms being rated for the very first time. We also find that this first-time under-rating moderates as time elapses, is lower for firms with higher financial leverage, and is less pronounced for larger companies, all of which are consistent with familiarity bias. We also examine the equity market impact, finding significant negative price performance surrounding inaugural credit ratings, quantifying the potential economic costs of familiarity bias.