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Multiple ratings and credit standards: differences of opinion in the credit rating industry

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  • Richard Cantor
  • Frank Packer

Abstract

This paper tests whether the tendency of third rating agencies to assign higher ratings than Moody's and Standard & Poor's results from more lenient standards or sample selection bias. More lenient standards might result from incentives to satisfy issuers who are, in fact, the purchasers of the ratings. Selection bias might be important because issuers that expect a low rating from a third agency are unlikely to request one. Our analysis of a broad sample of corporate bond ratings at year-end 1993 reveals that, although sample selection bias appears important, it explains less than half the observed difference in average ratings. The paper also investigates why bond issuers seek ratings in addition to those of Moody's and Standard & Poor's. Contrary to expectations, the probability of obtaining a third rating is not found to be related to levels of ex ante uncertainty over firm default probabilities. In particular, a firm's decision to obtain a third rating appears unrelated to its Moody's and Standard & Poor's ratings or the amount of disagreement between them. Instead, the most important determinants of the decision are a firm's age and size. The results should be of interest to investors and financial market regulators who generally use the ratings of different agencies as if they correspond to similar levels of default risk. In addition, our findings raise a number of questions about the certification role of rating agencies and about the strength of the rating agencies' incentives to maintain a reputation for high quality (accurate) ratings.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9527.

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Date of creation: 1995
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Handle: RePEc:fip:fednrp:9527

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Keywords: Credit ; Corporate bonds;

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Cited by:
  1. Miloš Božovic & Branko Uroševic & Boško Živkovic, 2011. "Credit Rating Agencies and Moral Hazard," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 58(2), pages 219-227, June.
  2. Shin, Yoon S. & Moore, William T., 2003. "Explaining credit rating differences between Japanese and U.S. agencies," Review of Financial Economics, Elsevier, vol. 12(4), pages 327-344.
  3. Cantor, Richard & Packer, Frank, 1997. "Differences of opinion and selection bias in the credit rating industry," Journal of Banking & Finance, Elsevier, vol. 21(10), pages 1395-1417, October.
  4. Santos, Joao A.C., 2006. "Why firm access to the bond market differs over the business cycle: A theory and some evidence," Journal of Banking & Finance, Elsevier, vol. 30(10), pages 2715-2736, October.
  5. Ying Yi Tsai & Li-Gang Liu, 2010. "Emergence of Rating Agencies : Implications for Establishing a Regional Rating Agency in Asia," Finance Working Papers 22824, East Asian Bureau of Economic Research.
  6. Morales, Jorge & Tuesta, Pedro, 1998. "Calificaciones de crédito y riesgo país," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 3.
  7. Daryl Koehn & Joe Ueng, 2005. "Evaluating the Evaluators: Should Investors Trust Corporate Governance Metrics Ratings?," Journal of Management and Governance, Springer, vol. 9(2), pages 111-128, 06.
  8. White, Lawrence J., 2005. "Good Intentions Gone Awry: A Policy Analysis of the SEC's Regulation of the Bond Rating Industry," Working paper 298, Regulation2point0.
  9. David Brookfield & Phillip Ormrod, 2000. "Credit agency regulation and the impact of credit ratings in the international bond market," The European Journal of Finance, Taylor & Francis Journals, vol. 6(4), pages 311-331.
  10. Alexandr Karminsky & Anatoly Peresetsky, 2009. "Ratings as Measure of Financial Risk: Evolution, Function and Usage," Journal of the New Economic Association, New Economic Association, issue 1-2, pages 86-102.

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