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The quality of credit ratings: A two-sided market perspective

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  • Ponce, Jorge

Abstract

This paper presents a formal model of a credit rating agency. I study the consequences of the transition from an “investor-pays” model to an “issuer-pays” model on the quality standard of credit ratings chosen by the agency. I find that such a transition is likely to generate a degradation of the quality standard, which may fall below the socially efficient level. Finally, I discuss empirical implications and several reform proposals to the business model of credit rating agencies.

Suggested Citation

  • Ponce, Jorge, 2012. "The quality of credit ratings: A two-sided market perspective," Economic Systems, Elsevier, vol. 36(2), pages 294-306.
    • Handle: RePEc:eee:ecosys:v:36:y:2012:i:2:p:294-306
    DOI: 10.1016/j.ecosys.2011.06.004
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    References listed on IDEAS

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    1. Forster, Josef, 2008. "The Optimal Regulation of Credit Rating Agencies," Discussion Papers in Economics 5169, University of Munich, Department of Economics.
    2. Jean‐Charles Rochet & Jean Tirole, 2006. "Two‐sided markets: a progress report," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 645-667, September.
    3. Felton, Andrew & Reinhart, Carmen M. (ed.), 2009. "The First Global Financial Crisis of the 21st Century Part II: June–December, 2008," Vox eBooks, Centre for Economic Policy Research, number p199.
    4. Skreta, Vasiliki & Veldkamp, Laura, 2009. "Ratings shopping and asset complexity: A theory of ratings inflation," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 678-695, July.
    5. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2012. "The Credit Ratings Game," Journal of Finance, American Finance Association, vol. 67(1), pages 85-112, February.
    6. Richard L. Johnson, 2003. "An examination of rating agencies' actions around the investment-grade boundary," Research Working Paper RWP 03-01, Federal Reserve Bank of Kansas City.
    7. Doh-Shin Jeon & Jean-Charles Rochet, 2010. "The Pricing of Academic Journals: A Two-Sided Market Perspective," American Economic Journal: Microeconomics, American Economic Association, vol. 2(2), pages 222-255, May.
    8. Perotti, Enrico C. & Suarez, Javier, 2002. "Last bank standing: What do I gain if you fail?," European Economic Review, Elsevier, vol. 46(9), pages 1599-1622, October.
    9. Richard Cantor & Frank Packer, 1994. "The credit rating industry," Quarterly Review, Federal Reserve Bank of New York, vol. 19(Sum), pages 1-26.
    10. Jean-Charles Rochet & Jean Tirole, 2003. "Platform Competition in Two-Sided Markets," Journal of the European Economic Association, MIT Press, vol. 1(4), pages 990-1029, June.
    11. Mathis, Jérôme & McAndrews, James & Rochet, Jean-Charles, 2009. "Rating the raters: Are reputation concerns powerful enough to discipline rating agencies?," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 657-674, July.
    12. Becker, Bo & Milbourn, Todd, 2011. "How did increased competition affect credit ratings?," Journal of Financial Economics, Elsevier, vol. 101(3), pages 493-514, September.
    13. Beaver, William H. & Shakespeare, Catherine & Soliman, Mark T., 2006. "Differential properties in the ratings of certified versus non-certified bond-rating agencies," Journal of Accounting and Economics, Elsevier, vol. 42(3), pages 303-334, December.
    14. Stolper, Anno, 2009. "Regulation of credit rating agencies," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1266-1273, July.
    15. Jean-Charles Rochet Author-Email:rochet@cict.fr Author-Workplace-Name: IDEI, University of Toulouse & Jean Tirole Author-Email: tirole@cict.fr Author-Workplace-Name: IDEI, University of Toulouse, 2006. "Two-Sided Markets: A Progress Report," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 645-667, Autumn.
    16. Mark Armstrong Author-Email: mark.armstrong@ucl.ac.uk Author-Workplace-Name: University College of London, 2006. "Competition in Two-Sided Markets," RAND Journal of Economics, The RAND Corporation, vol. 37(3), pages 668-691, Autumn.
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    Citations

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    Cited by:

    1. Lannoo, Karel, 2010. "What reforms for the credit rating industry? A European perspective," ECMI Papers 3805, Centre for European Policy Studies.
    2. Nicolas Jannone Bellot, MaLuisa Marti Selva, Leandro Garcia Menendez, 2017. "Herding Behaviour among Credit Rating Agencies," Journal of Finance and Economics Research, Geist Science, Iqra University, Faculty of Business Administration, vol. 2(1), pages 56-83, March.
    3. Charoontham, Kittiphod & Amornpetchkul, Thunyarat (Bam), 2018. "Performance-based payment scheme to hedge against credit rating inflation," Research in International Business and Finance, Elsevier, vol. 44(C), pages 471-479.
    4. Belleflamme, Paul & Peitz, Martin & Toulemonde, Eric, 2022. "The tension between market shares and profit under platform competition," International Journal of Industrial Organization, Elsevier, vol. 81(C).
    5. Luitel, Prabesh & Vanpée, Rosanne & De Moor, Lieven, 2016. "Pernicious effects: How the credit rating agencies disadvantage emerging markets," Research in International Business and Finance, Elsevier, vol. 38(C), pages 286-298.
    6. Nestor Duch-Brown, 2017. "Quality discrimination in online multi-sided markets," JRC Working Papers on Digital Economy 2017-06, Joint Research Centre.
    7. repec:mth:ijafr8:v:9:y:2019:i:1:p:209-228 is not listed on IDEAS
    8. Donato Masciandaro, 2013. "Sovereign debt: financial market over-reliance on credit rating agencies," BIS Papers chapters, in: Bank for International Settlements (ed.), Sovereign risk: a world without risk-free assets?, volume 72, pages 50-62, Bank for International Settlements.

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    More about this item

    Keywords

    Credit rating agencies; Issuer-pays; Investor-pays; Two-sided market; Endogenous quality;
    All these keywords.

    JEL classification:

    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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