Does credit rating agency reputation matter in China’s local government bond market?

Abstract

All issuers in China’s local government bond market, which is nascent but growing rapidly, have the same AAA ratings. However, we provide evidence that the credit rating agency’s reputation can certify differences in ratings’ reliability and further impact bond pricing. On the basis of a sample of 7941 local government bonds issued from 2015 to 2021, results show that risk premium is significantly low for bonds rated by prestigious credit rating agencies, which means that issuers can save borrowing costs. Moreover, local governments regarded as less transparent in fiscal information disclosure enjoy more cost savings for their bonds by hiring more reputable agencies. Regression results are affirmed with the Heckman two-stage model, difference-in-differences regression, and machine learning method to solve the potential endogeneity issue. This paper’s findings contribute to the debate on the credit rating agency’s reputation hypothesis and present three implications. First, investors can rely on the credit rating agency’s reputation to complement credit risk analysis. Second, local government policymakers should implement appropriate policies to reduce debt costs and improve public finance sustainability. Lastly, regulators should considerably focus on the supervision of credit rating agencies, given their substantial impact on bond pricing and the market’s information asymmetry.