Geographic Location of the Firm and Credit Rating Accuracy

Abstract

We document in this study that lack of soft information as a result of longer distance between the firm and rating agency headquarters leads to higher errors in bond ratings, reflected by Type-1 and Type-2 errors for missed defaults and false warnings, respectively. Our results show that for each 100 kilometers in terms of the distance between a firm’s and the rating agency headquarters, the likelihood of missed defaults (Type-1 error) increases by 4.9 percent and false warnings (Type-2 error) increases by 2.1 percent. Additionally, our analyses show that the downgrades are less timely for firms that are further away from the rating agency headquarters. The results also show that missed defaults are especially higher and timeliness of downgrades is lower for firms with higher complexity, lower analyst following, and lower accessibility to the rating agency headquarters. Though analysts adjust their ratings lower when soft information is lacking as a result of longer distance, their adjustments do not fully compensate for the lack of soft information.

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