The Economic Consequences of Corporate Credit Rating Errors

We examine a systematic and economically important error in the quantitative adjustments made by the major credit rating agencies which affected firms with minimum liability reporting requirements for their defined benefit pension plans. This error was corrected by the adoption of Financial Accounting Standards Board Statement No. 158 (“SFAS158”), which changed the accounting requirements for defined benefit pension plans, rather than through any knowledge of the error by either the rating agencies or the rated firms. Using a variety of empirical specifications, we exploit this exogenous event to show that firms that were ex-ante more likely to benefit from the elimination of the rating agency error increased investment and shifted capital structure toward debt financing post-SFAS158. Overall, these results suggest that credit rating errors have real economic consequences for rated firms and that credit rating labels drive economic choices that are independent of firm credit quality.