Do Credit Rating Agencies Influence Elections?

July 30, 2022

Do Credit Rating Agencies Influence Elections
Igor Cunha, Miguel A Ferreira, Rui C Silva
Review of Finance, Volume 26, Issue 4, July 2022, Pages 937–969,

The long-standing debate about the role of financial markets in society has recently received additional attention due to the 2007-2009 global financial crisis and the 2010-2012 European sovereign debt crisis. The fear that financial institutions may have too much power has been voiced by regulators, academics, politicians, and in public opinion polls.

We ask whether credit ratings influence the electoral prospects of incumbent political parties. To answer this question we study the effects of municipal bond ratings on gubernatorial and mayoral elections in the United States. Our identification strategy exploits the exogenous variation in municipal bond ratings stemming from Moody’s recalibration of its municipal rating scale in 2010. Before the recalibration, Moody’s used a dual-class rating system. Moody’s Municipal Rating Scale measured the likelihood that a municipality reaches a financial position that would require support from a higher level of government. In contrast, Moody’s Global Rating Scale measured the default probability and loss in default among sovereign and corporate bonds. In April-May 2010, Moody’s recalibrated its Municipal Rating Scale to align it with the Global Rating Scale. The recalibration resulted in upgrades by up to three notches of nearly 18,000 local governments, corresponding to bonds worth more than $2.2 trillion in par value (about 70,000 bond issues).

We find that incumbent party candidates obtained a higher vote share in upgraded counties than in non-upgraded counties. Our results for gubernatorial elections show that a 10% increase in the fraction of upgraded local government units in a county is associated with a 0.7 percentage point increase in the incumbent’s vote share relative to non-upgraded neighboring counties. Ratings affect election outcomes by energizing the incumbent’s base and by decreasing electoral competition. Upgraded counties experience increases in the number of votes cast and a decrease in the number of candidates in the race.

Credit rating upgrades affect voting behavior by improving economic conditions and affecting voters’ perceptions of the quality of incumbent politicians. The reduced borrowing costs generated by the upgrades allowed upgraded municipalities to increase bond issuance and spending (or reduce taxes). These fiscal policy changes spillover to the private sector, increasing employment and income, benefiting the incumbent party. Consistent with the certification channel, we also find that the recalibration had a more significant effect on elections where voters were more informed about the rating upgrades as proxied by the number of news searches for “credit ratings” and in states with more local newspapers.

Our results highlight the influence of financial markets on the political process. Credit Rating Agencies (CRAs) may have an outsize power, as they can affect elections’ outcomes and, therefore, alter public policy choices. However, there is also a potential bright side. Democracy is an imperfect system. It is typically challenging to oust a politician during his or her term. CRAs can act as a disciplining force that limits the actions of politicians of ill will. Our findings suggest that regulators should be aware that financial markets can affect the political process when designing the financial system’s rules.