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Investor-Paid Ratings and Conflicts of Interest

Author

Listed:
  • Leo Tang

    (Lehigh University)

  • Marietta Peytcheva

    (Lehigh University)

  • Pei Li

    (Southwestern University of Finance and Economics - School of Accounting)

Abstract

The Securities and Exchange Commission (SEC) sanctioned investor-paid rating agency Egan-Jones for falsely stating that it did not know its clients’ investment positions. The SEC’s action against Egan-Jones raises the broad question whether knowledge of clients’ investment positions creates a conflict of interest for investor-paid ratings. In an experimental setting, we find that investor-paid rating agencies are likely to assign credit ratings that are biased in favor of their clients’ positions, and that this effect is attenuated when the rated company has a sophisticated investor base that is expected to scrutinize ratings. The effect is not conditional on the risk profile of the rated companies. Taken together, our findings suggest that a conflict of interest stemming from investors’ preferences is likely to bias ratings under investor-pays business models, but scrutiny by the company’s investor base can counteract this bias.

Suggested Citation

  • Leo Tang & Marietta Peytcheva & Pei Li, 2020. "Investor-Paid Ratings and Conflicts of Interest," Journal of Business Ethics, Springer, vol. 163(2), pages 365-378, May.
  • Handle: RePEc:kap:jbuset:v:163:y:2020:i:2:d:10.1007_s10551-018-4042-8
    DOI: 10.1007/s10551-018-4042-8
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    References listed on IDEAS

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    Cited by:

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    2. Wai Choi Lee & Jianfu Shen & Tsun Se Cheong & Michal Wojewodzki, 2021. "Detecting conflicts of interest in credit rating changes: a distribution dynamics approach," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-23, December.
    3. Russo Lopes, Gabriela & Bastos Lima, Mairon G. & Reis, Tiago N.P. dos, 2021. "Maldevelopment revisited: Inclusiveness and social impacts of soy expansion over Brazil’s Cerrado in Matopiba," World Development, Elsevier, vol. 139(C).
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    5. Kamran Ahmed Siddiqui & Ishtiaq Ahmed Bajwa & Faisal Al-Hudithi & Tarig Eltayeb & Asma Khatoon & Suliman Bawardi, 2021. "Entrepreneurs' opinion towards credit rating in Saudi Arabia," Entrepreneurship and Sustainability Issues, VsI Entrepreneurship and Sustainability Center, vol. 9(2), pages 186-197, December.

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