Are Credit Ratings Politically Biased?

Political polarization is one of the most worried-about phenomena of the age, spurring populism, legislative gridlock, and social tension. In the United States, not only Congress and voters but even institutions such as the Supreme Court, long considered above the fray, are becoming more polarized.

Chicago Booth’s Elisabeth Kempf and Cornell’s Margarita Tsoutsoura find evidence that finance, too, is becoming politically polarized: their research reveals that the assessments of credit analysts can reflect their opinions of the sitting president.

Whether partisan bias influences such economic opinions has been an “unexplored and frequently debated question,” the researchers write.

The researchers mined voter-registration records for the party affiliations of 449 analysts from the Big Three crediting rating agencies: Fitch, Moody’s, and Standard and Poor’s. These analysts—whose decisions, along with their colleagues’, can raise or lower the costs of doing business—rated 1,778 US companies from 2000 to 2015.

When downgrading a company’s credit rating, analysts who identified as Democrats adjusted a little lower when the president was a Republican. The opposite was also true, with Republican analysts’ pessimism growing when the president was a Democrat, according to Kempf and Tsoutsoura.

The average rating downgrade during this period was 0.16 notches, where one notch would move a AAA rating to AAA-, for example. But downgrades were an additional 9 percent lower―0.015 notches―when coming from an analyst whose political leanings differed from those of the president.

“If you were to take the average US issuer and replace a misaligned analyst with one who is aligned with the president, there would be a difference in investment of about 2.8 percent.”

–Elisabeth Kempf

“We interpret the evidence in this paper as showing that analysts with opposing political views differ in their beliefs about how the economic policies of the US president affect the future state of the economy and, as a result, the credit risk of firms in the economy,” the researchers write.

As ratings are adjusted quarterly, these small fractions can add up over a single four-year term of a president.

“This actually can affect financing policies and investment policies,” Kempf says. “If you were to take the average US issuer and replace a misaligned analyst with one who is aligned with the president, there would be a difference in investment of about 2.8 percent.”

The bias vanished when analysts rated foreign companies or domestic enterprises whose success was unlikely to change on the basis of a president’s economic policies, suggesting that a president’s politics were what moved the needle.

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Current events also affected ratings. The Federal Reserve Bank of Philadelphia’s Partisan Conflict Index uses newspaper articles to track the degree of disagreement among federal politicians, including Congress and the president. When the index rose between 2000 and 2015, an analyst’s partisan bias increased. This bias was also bigger during presidential election quarters and among analysts who voted frequently.

“To the best of our knowledge, this is the first study to identify a significant effect of partisan bias on the behavior of finance professionals,” the researchers write. “Given the documented increase in political polarization, it is important to understand the potential implications of this trend for the US economy.”

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