publication . Article . Preprint . 2012

Credit rating and competition

Nelson Camanho; Pragyan Deb; Zijun Liu;
Open Access
  • Published: 04 Jan 2012 Journal: International Journal of Finance & Economics (issn: 1076-9307, eissn: 1099-1158, Copyright policy)
  • Publisher: Wiley
Abstract
In principle, credit rating agencies are supposed to be impartial observers that bridge the gap between private information of issuers and the information available to the wider pool of investors. However, since the 1970s, rating agencies have relied on an issuer-pay model, creating a conflict of interest the largest source of income for the rating agencies are the fees paid by the issuers the rating agencies are supposed to impartially rate. In this paper, we explore the trade-off between reputation and fees and find that relative to monopoly, rating agencies are more prone to inflate ratings under competition, resulting in lower expected welfare. Our results s...
Subjects
free text keywords: Economics and Econometrics, Accounting, Finance, Welfare, media_common.quotation_subject, media_common, Financial regulation, Economics, Finance, business.industry, business, Monopoly, Reputation, Issuer, Private information retrieval, Credit rating, Conflict of interest, Bond credit rating, Microeconomics, Credit enhancement, Credit reference
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1This was o cially recognised by the Securities and Exchange Commission (SEC) in the 1970s when the big three rating agencies { Standard & Poor's, Moody's and Fitch were designated self-regulatory entities. See Lowenstein (2008).

2It is also interesting to note that rating agencies are some of the most pro table businesses. Moody's has been the third most-pro table company in the S&P 500-stock index from 2002 to 2007, based on pretax margins (ahead of both Microsoft and Google).

3Summary Report of Issues Identi ed in the Commission Sta s Examinations of Select Credit Rating Agencies by the Sta of the Securities and Exchange Commission, 2008, p.9.

8This is a standard simplifying assumption in the literature. See Mathis, McAndrews, and Rochet (2009) and Skreta and Veldkamp (2008).

9New York Times Magazine, Triple-A-Failure, April 27, 2008.

10Given the structure of the market, with Moody's and S&P controlling nearly 80% of the market, we believe that this is a reasonable approximation of reality. Klein, B., and K. B. Le er, 1981, \The Role of Market Forces in Assuring Contractual Performance," The Journal of Political Economy, 89(4), 615{641.

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