Credit rating agencies’ assessments of related party transactions

Abstract

This study examines the impact of Related Party Transactions (RPTs) on credit risk assessments by credit rating agencies (CRAs). Using a comprehensive dataset and a fixed effects regression model, we find that CRAs differentiate between financing and operating RPTs, generally assigning lower credit ratings to firms with financing RPTs while awarding higher ratings to those with operating RPTs. Further analysis reveals that CRAs distinguish between equity and debt-related financing RPTs, with firms engaging in debt-related RPTs receiving lower ratings, likely due to the potential risk that these transactions create by facilitating cash tunneling and strategic defaults. Conversely, equity-related RPTs do not significantly impact ratings. Additionally, CRAs assess RPTs within group-affiliated firms and material RPTs of firm with superior governance structures favorably. CRAs favorably view material RPTs by group firms in financial distress suggesting these RPTs reduce default risk. Overall, this study demonstrates that CRAs integrate RPT information into credit risk assessments and thus contributes to the understanding of CRA rating processes and the role of RPTs in credit risk assessments.