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Reputation as an Entry Barrier in the Credit Rating Industry

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  • Jeon, Doh-Shin
  • Lovo, Stefano

Abstract

We study competition between an incumbent Credit Rating Agency (CRA) and a sequence of entrant CRAs that are potentially more effective but whose ability in appraising default risk is unproven when they enter the market. We show that free entry competition fails to select the most competent CRA as long as two conditions are met. First, investors and issuers trust the incumbent CRA to provide a sincere, although imperfect, assessment. Second, CRAs cannot charge higher fees for low rating than for high rating. Then, a rather incompetent CRA can dominate the market without concerns about entry. We derive policy implications.

Suggested Citation

  • Jeon, Doh-Shin & Lovo, Stefano, 2011. "Reputation as an Entry Barrier in the Credit Rating Industry," IDEI Working Papers 675, Institut d'Économie Industrielle (IDEI), Toulouse, revised 25 May 2012.
  • Handle: RePEc:ide:wpaper:24498
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    References listed on IDEAS

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    1. Antoine Faure-Grimaud & Eloïc Peyrache & Lucía Quesada, 2009. "The ownership of ratings," RAND Journal of Economics, RAND Corporation, vol. 40(2), pages 234-257.
    2. 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.
    3. Patrick Bolton & Xavier Freixas & Joel Shapiro, 2012. "The Credit Ratings Game," Journal of Finance, American Finance Association, vol. 67(1), pages 85-112, February.
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    5. Emmanuel Farhi & Josh Lerner & Jean Tirole, 2013. "Fear of rejection? Tiered certification and transparency," RAND Journal of Economics, RAND Corporation, vol. 44(4), pages 610-631, December.
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    7. Paolo Fulghieri & Günter Strobl & Han Xia, 2014. "The Economics of Solicited and Unsolicited Credit Ratings," Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 484-518.
    8. 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.
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    Cited by:

    1. Jeon, Doh-Shin & Lovo, Stefano, 2013. "Credit rating industry: A helicopter tour of stylized facts and recent theories," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 643-651.
    2. Hirth, Stefan, 2014. "Credit rating dynamics and competition," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 100-112.

    More about this item

    Keywords

    Credit Rating; Entry Barrier; Reputation; Credit Constraint; Private Information;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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