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Reputation as an Entry Barrier in the Credit Rating Industry

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  • Jeon, Doh-Shin
  • Lovo, Stefano
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    Abstract

    We study competition between an incumbent Credit Rating Agency (CRA) and a sequence of entrant CRAs that are potentially more e¤ective but whose ability in appraising default risk is unproven when they enter the market. We show that free entry competition fails to select the most competent CRA as long as two conditions are met. First, investors and issuers trust the incumbent CRA to provide a sincere, although imperfect, assessment. Second, CRAs cannot charge higher fees for low rating than for high rating. Then, a rather incompetent CRA can dominate the market without concerns about entry. We derive policy implications.

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    Bibliographic Info

    Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 675.

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    Date of creation: 10 May 2011
    Date of revision: 25 May 2012
    Handle: RePEc:ide:wpaper:24498

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    Related research

    Keywords: Credit Rating; Entry Barrier; Reputation; Credit Constraint; Private Information;

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    1. Antoine Faure-Grimaud & Eloïc Peyrache & Lucía Quesada, 2009. "The ownership of ratings," RAND Journal of Economics, RAND Corporation, vol. 40(2), pages 234-257.
    2. Bar-Isaac, Heski & Shapiro, Joel, 2010. "Ratings Quality over the Business Cycle," CEPR Discussion Papers 8156, C.E.P.R. Discussion Papers.
    3. Reinhart, Carmen & Levich, Richard & Majoni, Giovanni, 2002. "Ratings, rating agencies and the global financial system: Summary and policy implications," MPRA Paper 13249, University Library of Munich, Germany.
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    Cited by:
    1. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit Rating Industry: a Helicopter Tour of Stylized Facts and Recent Theories," TSE Working Papers 13-376, Toulouse School of Economics (TSE).
    2. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit Rating Industry: a Helicopter Tour of Stylized Facts and Recent Theories," IDEI Working Papers 762, Institut d'Économie Industrielle (IDEI), Toulouse.
    3. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit rating industry: A helicopter tour of stylized facts and recent theories," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 643-651.

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