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Testing conflicts of interest at bond rating agencies with market anticipation: evidence that reputation incentives dominate

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Author Info
Daniel M. Covitz
Paul Harrison
Abstract

This paper presents the first comprehensive test of whether well-known conflicts of interest at bond rating agencies importantly influence their actions. This hypothesis is tested against the alternative that rating agency actions are primarily influenced by a countervailing incentive to protect their reputations as delegated monitors. These two hypotheses generate a number of testable predictions regarding the anticipation of credit-rating downgrades by the bond market, which we investigate using a new data set of about 2,000 credit rating migrations from Moody's and Standard & Poor's, and matching issuer-level bond prices. The findings strongly indicate that rating changes do not appear to be importantly influenced by rating agency conflicts of interest but, rather, suggest that rating agencies are motivated primarily by reputation-related incentives.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2003-68.

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Date of creation: 2003
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Handle: RePEc:fip:fedgfe:2003-68

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Related research
Keywords: Bonds;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Diamond, Douglas W, 1991. "Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 689-721, August. [Downloadable!] (restricted)
  2. Hand, John R M & Holthausen, Robert W & Leftwich, Richard W, 1992. " The Effect of Bond Rating Agency Announcements on Bond and Stock Prices," Journal of Finance, American Finance Association, vol. 47(2), pages 733-52, June. [Downloadable!] (restricted)
  3. Richard Cantor & Frank Packer, 1994. "The credit rating industry," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 1-26.
  4. Goh, Jeremy C. & Ederington, Louis H., 1999. "Cross-sectional variation in the stock market reaction to bond rating changes," The Quarterly Review of Economics and Finance, Elsevier, vol. 39(1), pages 101-112. [Downloadable!] (restricted)
  5. Bulow, Jeremy & Rogoff, Kenneth, 1989. "Sovereign Debt: Is to Forgive to Forget?," American Economic Review, American Economic Association, vol. 79(1), pages 43-50, March. [Downloadable!] (restricted)
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  6. Donald P. Morgan, 2002. "Rating Banks: Risk and Uncertainty in an Opaque Industry," American Economic Review, American Economic Association, vol. 92(4), pages 874-888, September. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. André Güttler & Mark Wahrenburg, 2007. "The Adjustment of Credit Ratings in Advance of Defaults," Working Paper Series: Finance and Accounting 155, Department of Finance, Goethe University Frankfurt am Main. [Downloadable!]
  2. Masami Imai, 2006. "Market Discipline and Deposit Insurance Reform in Japan," Wesleyan Economics Working Papers 2006-007, Wesleyan University, Department of Economics. [Downloadable!]
  3. John Ammer & Nathanael Clinton, 2004. "Good news is no news? The impact of credit rating changes on the pricing of asset-backed securities," International Finance Discussion Papers 809, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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