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Credit Rating and Competition

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Author Info

  • Nelson Camanho

    ()

  • Pragyan Deb

    ()

  • Zijun Liu

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 suggest that more competition by itself is undesirable under the current issuer-pay model and will do little to resolve the conflict of interest problem.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/DP653_2010_CreditRatingsandCompetitionAversion.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp653.

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Date of creation: Apr 2010
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Handle: RePEc:fmg:fmgdps:dp653

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Web page: http://www.lse.ac.uk/fmg/

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  1. Bo Becker & Todd Milbourn, 2008. "Reputation and competition: evidence from the credit rating industry," Harvard Business School Working Papers 09-051, Harvard Business School, revised Sep 2010.
  2. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2010. "The Credit Ratings Game," Working Papers 468, Barcelona Graduate School of Economics.
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Cited by:
  1. Manso, Gustavo, 2013. "Feedback effects of credit ratings," Journal of Financial Economics, Elsevier, vol. 109(2), pages 535-548.

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