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This paper provides new evidence concerning the information content of debt ratings. The authors find systematic biases in the rating of subordinated debt. Yields of speculative senior bonds are higher than the yields of identically rated subordinated bonds suggesting that rating agencies follow a conservative policy when the probability of default is high. The relation reverses in most cases for highly-rate bond issues. These findings are consistent with a framework which suggests that rating subordinated issues, which are few in number, may not be cost effective, and that rating agencies use an arbitrary policy. This policy balances two conflicting effects-an optimistic bias to favor paying customers, and a pessimistic bias to avoid potential lawsuits and investigations.
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