Regulatory punishment in an oligopolistic market: Evidence from credit rating agencies

Regulatory punishment in an oligopolistic credit rating market can be costly. Utilizing the Chinese bond market’s unique features, particularly a third-party rating agency, we investigate the regulatory suspension of Dagong Rating by Chinese regulators and its market impact. The punishment initially deters Dagong but diminishes the quality of its ratings post-punishment, altering market competition. Upon returning, Dagong inflates ratings to regain market share, reflecting a “temporary suppression” strategy. Non-Dagong agencies respond by adjusting their ratings; higher power agencies lower ratings, while lower power agencies raise them to stay competitive. Investors remain skeptical of these inflated ratings. Despite Dagong’s suspension, we find no significant differences in bond or stock price reactions between Dagong-rated and non-Dagong-rated firms, suggesting investors did not penalize Dagong-rated entities. This study highlights the complex dynamics and unintended consequences of regulatory interventions in the credit rating market.