Government Guarantee, Information Acquisition and Credit Rating Informativeness: Theory and Evidence from China

We examine the influence of implicit government guarantees on the information content of credit ratings in China, guided by a theoretical credit rating game model in the presence of government guarantees. Using issuers’ controlling shareholder identity as the defining metric of implicit government guarantees, we document a less sensitive relationship between credit ratings and primary market offer yields for SOE bonds (i.e., bonds issued by firms controlled by government or government related agencies) than that for non-SOE bonds. Moreover, ratings of non-SOE bonds have a stronger predictive power on both future downgrades and a market-based measure of issuer-expected default probability than those of SOE bonds. These findings are robust to considering the unobserved influence of the controlling shareholder identity on security pricing and bond default risk. Taken together, our empirical findings are consistent with the model’s prediction that government guarantees can dampen the incentives for credit rating agencies to acquire costly information, thus lowering the equilibrium informativeness of ratings for SOE bonds.