The impact of non-punitive regulation on credit rating: Evidence from China

This study investigates the impact of non-punitive regulation on credit ratings using China’s context. The results show that when credit rating agencies (CRAs) are subject to non-punitive regulation, they issue higher credit ratings, indicating that non-punitive regulation aggravates conflicts of interest and rating inflation. Furthermore, the impact of non-punitive regulation on credit ratings is more evident when CRAs face higher levels of conflict of interest. Clients of CRAs subject to non-punitive regulation are also less likely to switch to other CRAs for follow-up ratings. Heterogeneity tests reveal that the impact of non-punitive regulation on credit ratings is greater when competition in the rating industry is fiercer or rating agencies are smaller. And the impact is also greater for firms with higher financial risk, tighter financing constraints, or non-state ownership. Finally, non-punitive regulation reduces the information content of credit ratings. The results indicate that non-punitive regulation induces CRAs to cater to clients rather than improve credit rating quality. These findings also have implications for the regulatory practices of other countries.