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The Notching Rule for Subordinated Debt and the Information Content of Debt Rating
Author(s) -
John Kose,
Ravid S. Abraham,
Reisel Natalia
Publication year - 2010
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2010.01081.x
Subject(s) - debt , notching , rule of thumb , investment (military) , business , order (exchange) , information asymmetry , yield (engineering) , empirical evidence , economics , monetary economics , actuarial science , finance , computer science , engineering , mechanical engineering , philosophy , algorithm , epistemology , politics , law , political science , materials science , metallurgy
This paper provides new evidence regarding the information content of debt ratings. We show that noninvestment grade subordinated issues are consistently priced too high (the yield is too low), and the reverse is true for some investment grade bonds. We relate this empirical bias to a notching rule of thumb that is used in order to rate subordinated debt without expending additional resources for information production. We propose an explanation for these findings based upon a balance between an attempt to please the companies that pay the raters versus a concern for lawsuits and regulatory investigations should ratings be too optimistic.