The Conservative Issuer Bias of Corporate Ratings

In contrast to existing literature that relates positive issuer bias in ratings to a conflict of interest, we document a bias in corporate ratings resulting from a conservative rating policy that accounts for the asymmetric impact of a rating downgrade on firms' access to capital. Specifically, using Moody's issuer ratings over 1982-2009, firms with greater external financing constraints are less likely to be downgraded. Economically, external financing constraints are more important than the default risk of the firm in determining the outcome of a rating review. Severely constrained firms whose ratings are affirmed or upgraded have long-term positive excess equity returns