CEO political ideology and credit risk assessment

Abstract

In this study, I examine the role of CEO political ideology in the credit rating process. Credit rating agencies release their research methodologies for determining corporate credit ratings and identify managerial conservatism as one important factor that affects their risk assessments. The extant literature, however, has not investigated the relation between credit ratings and managerial conservatism, which, according to behavioral consistency theory, can be proxied by CEO political ideology. I hypothesize and find that firms run by Republican-leaning CEOs, who tend to have conservative political ideologies, enjoy more favorable credit ratings than firms run by Democratic-leaning CEOs. This finding holds after controlling for potential endogeneity and self-selection concerns, and is robust to a battery of sensitivity checks. In addition, I find that the association between CEO political ideology and credit ratings is more pronounced for firms with high uncertainty of information environment and for firms with weak corporate governance. I further mitigate the concern that economic bonding between CEOs and credit rating agencies may drive the results. Finally, I identify future earnings volatility and future return volatility as two possible channels through which CEO political ideology affects credit ratings, and show that CEO political ideology has a residual effect on credit ratings after controlling for these two channel variables.