Virtual Lecture: Exorbitant Privilege? The Bond Market Subsidy of Prospective Fallen Angels

Risky firms just above the investment-grade rating cutoff face the prospect of becoming “fallen angels” upon a downgrade. We document that their bond issuance, especially during periods of monetary easing after the global financial crisis, enjoyed low borrowing costs relative to their non-rating based credit risk measures. This “exorbitant privilege” appears to originate in credit rating inflation, valued by yield-seeking investors. In response, prospective fallen angels increase their  market share by making value-destroying but leverage-enhancing acquisitions that increase the extent of their downgrade stress during times of aggregate risk. In addition, these firms reduce markups, forcing their competitors to reduce employment, investment, markups, and sales, implying real effects and spillovers from their exorbitant privilege.

To join the lecture via ZOOM, please contact Melina Ludolph.