The impact of short-selling threats on credit rating performance and usage: Evidence from a natural experiment

Using Regulation SHO as a controlled experiment, we examine the impact of short-selling threats on credit rating performance and credit rating usage in debt contracts. We find that when short-selling constraints are removed for pilot firms, rating accuracy increases, but rating stability decreases for these firms relative to non-pilot firms. This result suggests that short-selling threats push rating agencies to enhance rating accuracy at the cost of rating stability. We also find less rating usage in debt contracts for pilot firms than for non-pilot firms when short-selling constraints are removed for pilot firms, suggesting that in the presence of short-selling threats, debt contracting parties emphasize rating stability over rating accuracy. Overall, our study informs academics, practitioners and regulators about short sellers’ disciplining effect on rating agencies and provides novel evidence on the rating property trade-off and its implication for rating usage.