This paper analyzes how the size of firms, unrelated to inherent credit risks, influences firms’ access to capital markets. Specifically, we theoretically and empirically whether credit rating agencies (CRAs) unduly give favors to large-sized companies and conglomerates than small and mid-sized companies when CRAs evaluate default risks of these companies on their debts. In a simple theory model in a Bayesian persuasion framework, we find that CRAs have an incentive to generously underestimate default risks on the large-sized firms when these firms raise capital from bond markets more often than small and mid-sized firms, and thus become a very important client to CRAs. However, the bond buyers rationally infer the default risks on these large-sized companies with high credit rating, and thus charges a higher risk premium than they would to small and mid-sized companies conditional on the same financial conditions. Using a financial dataset in Korea, we document that the interest rates of bonds issued by mid-sized companies are in fact lower on average than those issued by large-sized companies. We further find that mid-sized companies are less likely to receive a high credit rating than the large-sized companies. These findings suggest that CRAs unfairly treat companies willing to issue bonds based on their sizes, thereby possibly distorting credit market structures.

Preface
Executive Summary

Chapter 1 Introduction

Chapter 2 Overview and Implications of Corporate Funding Structures in Korea

Chapter 3 Theoretical Analysis: Impact of Firm Size on Credit Rating Agencies’ Incentive Structures
　Section 1 Model
　Section 2 Benchmark: A Single-Firm Economy
　Section 3 Equilibrium Analysis: Establishing Differential Credit Rating Standards

Chapter 4 Empirical Analysis: Correlation Between Firm Size and Corporate Bond Credit Ratings
　Section 1 Hypothesis Development
　Section 2 Statistical Data for Analysis
　Section 3 Empirical Analysis
　Section 4 Policy Implications

Chapter 5 Conclusion

References
ABSTRACT