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Credit Rating and Competition

Author

Listed:
  • Nelson Camanho

  • Pragyan Deb

  • Zijun Liu

Abstract

In principle, credit rating agencies are supposed to be impartial observers that bridge the gap between private information of issuers and the information available to the wider pool of investors. However, since the 1970s, rating agencies have relied on an issuer-pay model, creating a conflict of interest the largest source of income for the rating agencies are the fees paid by the issuers the rating agencies are supposed to impartially rate. In this paper, we explore the trade-off between reputation and fees and find that relative to monopoly, rating agencies are more prone to inflate ratings under competition, resulting in lower expected welfare. Our results suggest that more competition by itself is undesirable under the current issuer-pay model and will do little to resolve the conflict of interest problem.

Suggested Citation

  • Nelson Camanho & Pragyan Deb & Zijun Liu, 2010. "Credit Rating and Competition," FMG Discussion Papers dp653, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp653
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    Cited by:

    1. 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.
    2. Gil Cohen, 2014. "On the Impact of Bond's Rating Changes on the Firm's Stock Price," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 5(1), pages 64-70, January.
    3. Keser, Claudia & Özgümüs, Asri & Peterlé, Emmanuel & Schmidt, Martin, 2017. "An experimental investigation of rating-market regulation," Journal of Economic Behavior & Organization, Elsevier, vol. 144(C), pages 78-86.
    4. Pragyan Deb & Mark Manning & Gareth Murphy & Adrian Penalver & Aron Toth, 2011. "Financial Stability Paper No 9: Whither the Credit Ratings Industry?," Bank of England Financial Stability Papers 9, Bank of England.
    5. Marta Allegra Ronchetti, 2018. "What if I knew you did it? An analysis of preliminary ratings’ disclosure under competition," Discussion Papers 2018/09, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    6. Bakhtiari, Ali & Murthi, B.P.S. & Steffes, Erin, 2013. "Evaluating the Effect of Affinity Card Programs on Customer Profitability Using Propensity Score Matching," Journal of Interactive Marketing, Elsevier, vol. 27(2), pages 83-97.
    7. Patrycja Chodnicka-Jaworska, 2016. "Credit Ratings Inflation Phenomenon – Are There Any Diffrences in the Credit Ratings Determinants? (Zjawisko inflacji credit ratingow – czy wystepuja roznice w determinantach credit ratingow?)," Research Reports, University of Warsaw, Faculty of Management, vol. 2(22), pages 48-59.
    8. Bongaerts, Dion, 2014. "Alternatives for issuer-paid credit rating agencies," Working Paper Series 1703, European Central Bank.
    9. Andreas Freytag & Martin Zenker, 2012. "The Credit Rating Market - Options for Appropriate Regulation," Global Financial Markets Working Paper Series 2012-39, Friedrich-Schiller-University Jena.
    10. Harald Hau & Sam Langfield & David Marques-Ibanez, 2013. "Bank ratings: what determines their quality? [Bank risk during the financial crisis: do business models matter?]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 28(74), pages 289-333.
    11. Christoph Buehren & Marco Plessner, 2014. "Rating Agencies: An Experimental Analysis of their Remuneration Model," MAGKS Papers on Economics 201454, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    12. Kraemer, Moritz & Klusak, Patrycja & Vu, Huong, 2020. "First-mover disadvantage - The sovereign ratings mousetrap," CEPS Papers 26352, Centre for European Policy Studies.
    13. Manso, Gustavo, 2013. "Feedback effects of credit ratings," Journal of Financial Economics, Elsevier, vol. 109(2), pages 535-548.
    14. Helmut Wasserbacher & Martin Spindler, 2024. "Credit Ratings: Heterogeneous Effect on Capital Structure," Papers 2406.18936, arXiv.org.
    15. Marrenbach, Ludwig, 2024. "Leveraging credit ratings through impression management: An exploratory study of German small and medium-sized family firms," Junior Management Science (JUMS), Junior Management Science e. V., vol. 9(2), pages 1511-1539.
    16. Chandan Sharma & Archana Singh & Rajan Yadav, 2023. "Impact of Competition in Credit Rating Industry: Evidence From India," SAGE Open, , vol. 13(1), pages 21582440221, January.
    17. Marta Allegra Ronchetti, 2015. "Credit Rating Agency, Preliminary Ratings and Contact Disclosure," Discussion Papers 2015/04, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    18. Gustavo Manso, 2011. "Feedback Effects of Credit Ratings," 2011 Meeting Papers 1338, Society for Economic Dynamics.
    19. Marta Allegra Ronchetti, 2018. "Preliminary credit ratings and contact disclosure," Discussion Papers 2018/02, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    20. Alsakka, Rasha & ap Gwilym, Owain & Vu, Tuyet Nhung, 2014. "The sovereign-bank rating channel and rating agencies' downgrades during the European debt crisis," Journal of International Money and Finance, Elsevier, vol. 49(PB), pages 235-257.

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