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Do Reputational Concerns Lead to Reliable Ratings?

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  • Beatriz Mariano

Abstract

This paper examines to what extent reputational concerns give rating agencies incentives to reveal information. It demonstrates that, in a simple model in which a rating agency has public and private information about a project, it may ignore private information and even contradict public information in an attempt to minimize reputational costs. A monopolistic agency can act conservatively by issuing too many bad ratings when a project is expected to be good based on private and public information. In a competitive setting, an agency becomes bolder and can issue too many good ratings when a project is expected to be bad based on private and public information. The paper provides a reason for why competition in the ratings industry might lead to overly optimistic ratings even in the absence of conflicts of interest.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp613.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp613.

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Date of creation: Jun 2008
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Handle: RePEc:fmg:fmgdps:dp613

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  1. Alessandro Lizzeri, 1999. "Information Revelation and Certification Intermediaries," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 214-231, Summer.
  2. Adam Brandenburger & Ben Polak, 1996. "When Managers Cover Their Posteriors: Making the Decisions the Market Wants to See," RAND Journal of Economics, The RAND Corporation, vol. 27(3), pages 523-541, Autumn.
  3. Morgan, J. & Stocken, P., 1998. "An Analysis of Stock Recommendations," Papers 204, Princeton, Woodrow Wilson School - Public and International Affairs.
  4. Benabou, R. & Laroque, G., 1988. "Using Privileged Information To Manipulate Markets: Insiders, Gurus And Credibility," Papers 19, Princeton, Woodrow Wilson School - Discussion Paper.
  5. Effinger, Matthias R. & Polborn, Mattias K., 2001. "Herding and anti-herding: A model of reputational differentiation," European Economic Review, Elsevier, vol. 45(3), pages 385-403, March.
  6. Zwiebel, Jeffrey, 1995. "Corporate Conservatism and Relative Compensation," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 1-25, February.
  7. Harrison Hong & Jeffrey D. Kubik & Amit Solomon, 2000. "Security Analysts' Career Concerns and Herding of Earnings Forecasts," RAND Journal of Economics, The RAND Corporation, vol. 31(1), pages 121-144, Spring.
  8. Sobel, Joel, 1985. "A Theory of Credibility," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 557-73, October.
  9. Trueman, Brett, 1994. "Analyst Forecasts and Herding Behavior," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 97-124.
  10. John R. Graham, 1999. "Herding among Investment Newsletters: Theory and Evidence," Journal of Finance, American Finance Association, vol. 54(1), pages 237-268, 02.
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Cited by:
  1. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2009. "The Credit Ratings Game," NBER Working Papers 14712, National Bureau of Economic Research, Inc.
  2. Bar-Isaac, Heski & Shapiro, Joel, 2013. "Ratings quality over the business cycle," Journal of Financial Economics, Elsevier, vol. 108(1), pages 62-78.
  3. Adam Ashcraft & Paul Goldsmith-Pinkham & James Vickery, 2010. "MBS ratings and the mortgage credit boom," Staff Reports 449, Federal Reserve Bank of New York.
  4. LI, Ming & MYLOVANOV, Tymofiy, 2010. "Credibility for Sale - The Effect of Disclosure on Information Acquisition and Transmission," Cahiers de recherche 08-2010, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
  5. Miele, Maria Grazia, 2012. "The financial crisis and the credit rating agencies: the failure of reputation," MPRA Paper 48159, University Library of Munich, Germany.

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