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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.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp613.

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Date of creation: Jun 2008
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Handle: RePEc:fmg:fmgdps:dp613
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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Find related papers by 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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  1. Alessandro Lizzeri, 1999. "Information Revelation and Certification Intermediaries," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 214-231, Summer.
  2. Zwiebel, Jeffrey, 1995. "Corporate Conservatism and Relative Compensation," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 1-25, February.
  3. Trueman, Brett, 1994. "Analyst Forecasts and Herding Behavior," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 97-124.
  4. 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.
  5. Benabou, R. & Laroque, G., 1988. "Using Privileged Information To Manipulate Markets: Insiders, Gurus And Credibility," Papers 19, Princeton, Woodrow Wilson School - Discussion Paper.
  6. Adam Brandenburger & Ben Polak, 1996. "When Managers Cover Their Posteriors: Making the Decisions the Market Wants to See," RAND Journal of Economics, The RAND Corporation, vol. 27(3), pages 523-541, Autumn.
  7. 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.
  8. 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.
  9. Morgan, John & Stocken, Phillip C, 2003. " An Analysis of Stock Recommendations," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 183-203, Spring.
  10. Joel Sobel, 1985. "A Theory of Credibility," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 557-573.
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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, 02.
  2. Adam B. Ashcraft & Paul Goldsmith-Pinkham & James Vickery, 2010. "MBS ratings and the mortgage credit boom," Staff Reports 449, Federal Reserve Bank of New York.
  3. 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.
  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. Bar-Isaac, Heski & Shapiro, Joel, 2010. "Ratings Quality over the Business Cycle," CEPR Discussion Papers 8156, C.E.P.R. Discussion Papers.

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