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Reputation and competition: evidence from the credit rating industry

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Author Info
Bo Becker () (Harvard Business School, Finance Unit)
Todd Milbourn () (Washington University, St. Louis.John M. Olin School of Business)

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Abstract

Fair and accurate credit ratings play an important role in the financial system, but investors and regulators who use ratings cannot easily verify their quality and ratings are paid for by the firms whose bonds are rated. The provision of quality ratings is at least partially sustained by the reputational concerns of the rating agencies. We use the rise of a third ratings agency to examine competition and reputation. Consistent with Klein and Leffler (1981), competition leads to lower quality in the ratings market: the incumbent agencies produce more issuer-friendly and less informative ratings when competition is stronger.

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Publisher Info
Paper provided by Harvard Business School in its series Harvard Business School Working Papers with number 09-051.

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Length: 43 pages
Date of creation: Oct 2008
Date of revision: Jul 2009
Handle: RePEc:hbs:wpaper:09-051

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Find related papers by JEL classification:
C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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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. Jorion, Philippe & Liu, Zhu & Shi, Charles, 2005. "Informational effects of regulation FD: evidence from rating agencies," Journal of Financial Economics, Elsevier, vol. 76(2), pages 309-330, May. [Downloadable!] (restricted)
  2. George J. Mailath & Larry Samuelson, . ""Who Wants a Good Reputation?''," CARESS Working Papres 98-12, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
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  3. Ingram, Robert W & Brooks, Leroy D & Copeland, Ronald M, 1983. " The Information Content of Municipal Bond Rating Changes: A Note," Journal of Finance, American Finance Association, vol. 38(3), pages 997-1003, June. [Downloadable!] (restricted)
  4. 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)
  5. 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. [Downloadable!] (restricted)
  6. John Y. Campbell & Glen B. Taksler, 2003. "Equity Volatility and Corporate Bond Yields," Journal of Finance, American Finance Association, vol. 58(6), pages 2321-2350, December. [Downloadable!] (restricted)
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  7. Holthausen, Robert W. & Leftwich, Richard W., 1986. "The effect of bond rating changes on common stock prices," Journal of Financial Economics, Elsevier, vol. 17(1), pages 57-89, September. [Downloadable!] (restricted)
  8. Diamond, Douglas W, 1989. "Reputation Acquisition in Debt Markets," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 828-62, August. [Downloadable!] (restricted)
  9. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August. [Downloadable!] (restricted)
  10. Shapiro, Carl, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 659-79, November. [Downloadable!] (restricted)
  11. Grier, Paul & Katz, Steven, 1976. "The Differential Effects of Bond Rating Changes among Industrial and Public Utility Bonds by Maturity," Journal of Business, University of Chicago Press, vol. 49(2), pages 226-39, April. [Downloadable!] (restricted)
  12. Cooper, Russell & Ross, Thomas W, 1984. "Prices, Product Qualities and Asymmetric Information: The Competitive Case," Review of Economic Studies, Blackwell Publishing, vol. 51(2), pages 197-207, April. [Downloadable!] (restricted)
  13. Arnoud W. A. Boot & Todd T. Milbourn & Anjolein Schmeits, 2006. "Credit Ratings as Coordination Mechanisms," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 19(1), pages 81-118. [Downloadable!] (restricted)
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  14. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May. [Downloadable!] (restricted)
  15. Bar-Isaac, Heski, 2005. "Imperfect competition and reputational commitment," Economics Letters, Elsevier, vol. 89(2), pages 167-173, November. [Downloadable!] (restricted)
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  1. Vasiliki Skreta & Laura Veldkamp, 2008. "Ratings Shopping and Asset Complexity: A Theory of Ratings Inflation," Working Papers 08-28, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
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