Rating friends: The effect of personal connections on credit ratings

- We study whether credit ratings are affected by the personal connections between directors of issuing companies and CRAs
- We report that ceteris paribus, issues by connected firms receive higher ratings
- The average difference in rating between issues by connected and unconnected firms is about one notch
- The higher ratings of connected companies are not due to favorable treatment but they reflect lower asymmetric information

Using a large sample of US public debt issues we show that personal connections between directors of issuing companies and rating agencies result in higher credit ratings. We estimate the average effect to be about one notch. Moreover, our tests indicate that issues by connected firms are 30% more likely to be rated A3. Results are robust to several alternative tests including additional controls for managerial traits, firm fixed effects, and propensity score matching. Furthermore, our tests on default rates and bond yields suggest that personal connections act as a mechanism to reduce asymmetric information between the rating agency and the issuer.