Does state ownership affect rating quality? Evidence from China's corporate bond market

The existing literature found that state ownership generally boosts bond ratings but ignores the implications for rating quality. Using China's corporate bonds issued from 2008 to 2018, we find that bonds issued by state-owned enterprises (SOEs) have relatively poorer rating quality than their non-SOE peers, as supported by the SOE ratings' weaker predictive power for future downward rating events. Importantly, the SOE ratings' poorer prediction performance is partly because of rating inflation; only relatively overrated SOE bonds contain less relevant information in ratings but not nonoverrated SOE bonds. This asymmetry in rating quality is prominent in the case of a local controlling government or when the SOE bonds are rated in booms wherein the incentive to inflate ratings is stronger. The evidence is consistent with a government guarantee induced rating bias where expected government guarantees reduce credit rating agencies' (CRAs') reputational costs and induce CRAs to inflate SOE ratings.