Abstract: In China’s bond market, government regulation is the basic force to maintain the orderly development of the bond market, and is the top-level foundation behind many factors affecting the bond market. Using samples of medium-term notes, corporate bonds and enterprise bonds issued by Chinese listed companies from 2014 to 2021, this paper examines the impact of regulatory penalties on credit rating agencies. The results show that the credit rating level decreases significantly after the regulatory punishment event, as the regulatory punishment has “deterrent effect”; further, this effect is more significant for non-state-owned credit rating agencies and bond issuers with poor information environment, while warning penalties and penalties from National Association of Financial Market Institutional Investors do not have “deterrent effect”. An examination on the economic consequences of “deterrent effect” shows that although the regulatory penalty increases the second type of errors of credit rating agencies, it reduces the first type of errors and the overall rating errors, indicating that although the “deterrent effect” causes the rating agencies to be overly cautious, it improves the rating accuracy on the whole. In addition, regulatory penalties significantly increase the information content of bond credit rating and improve the mismatch between bond credit rating and default risk. Finally, the dynamic test results show that the “deterrent effect” of regulatory penalties does exist, but only in short term and unsustainably. Finally, this paper has important implications for credit rating agencies to improve bond rating behavior and for bond market regulators to improve regulatory governance measures.

Key words: regulatory penalty, credit rating, rating quality, default risk