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Do Reputational Concerns Lead to Reliable Ratings?

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  • Beatriz Mariano

Abstract

This paper examines to what extent reputational concerns give rating agencies incentives to reveal information. It demonstrates that, in a simple model in which a rating agency has public and private information about a project, it may ignore private information and even contradict public information in an attempt to minimize reputational costs. A monopolistic agency can act conservatively by issuing too many bad ratings when a project is expected to be good based on private and public information. In a competitive setting, an agency becomes bolder and can issue too many good ratings when a project is expected to be bad based on private and public information. The paper provides a reason for why competition in the ratings industry might lead to overly optimistic ratings even in the absence of conflicts of interest.

Suggested Citation

  • Beatriz Mariano, 2008. "Do Reputational Concerns Lead to Reliable Ratings?," FMG Discussion Papers dp613, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp613
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/dp613.pdf
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    References listed on IDEAS

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    1. Effinger, Matthias R. & Polborn, Mattias K., 2001. "Herding and anti-herding: A model of reputational differentiation," European Economic Review, Elsevier, vol. 45(3), pages 385-403, March.
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    5. John R. Graham, 1999. "Herding among Investment Newsletters: Theory and Evidence," Journal of Finance, American Finance Association, vol. 54(1), pages 237-268, February.
    6. Zwiebel, Jeffrey, 1995. "Corporate Conservatism and Relative Compensation," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 1-25, February.
    7. Harrison Hong & Jeffrey D. Kubik & Amit Solomon, 2000. "Security Analysts' Career Concerns and Herding of Earnings Forecasts," RAND Journal of Economics, The RAND Corporation, vol. 31(1), pages 121-144, Spring.
    8. G. Ferri & L.-G. Liu & J. E. Stiglitz, 1999. "The Procyclical Role of Rating Agencies: Evidence from the East Asian Crisis," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 28(3), pages 335-355, November.
    9. Joel Sobel, 1985. "A Theory of Credibility," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 557-573.
    10. Alessandro Lizzeri, 1999. "Information Revelation and Certification Intermediaries," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 214-231, Summer.
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    Cited by:

    1. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2012. "The Credit Ratings Game," Journal of Finance, American Finance Association, vol. 67(1), pages 85-112, February.
    2. Li, Ming & Tymofiy Mylovanov, 2009. "Credibility for Sale: the Effect of Disclosure on Information Acquisition and Transmission," Working Papers 09008, Concordia University, Department of Economics, revised Oct 2009.
    3. Bar-Isaac, Heski & Shapiro, Joel, 2013. "Ratings quality over the business cycle," Journal of Financial Economics, Elsevier, vol. 108(1), pages 62-78.
    4. Loerke, Petra & Niedermayer, Andreas, 2015. "Crises and Rating Agencies," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 521, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    5. Miele, Maria Grazia, 2012. "The financial crisis and the credit rating agencies: the failure of reputation," MPRA Paper 48159, University Library of Munich, Germany.
    6. Ashcraft, A. & Goldsmith-Pinkham, P. & Vickery, J., 2010. "MBS Ratings and the Mortgage Credit Boom," Discussion Paper 2010-89S, Tilburg University, Center for Economic Research.

    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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