The Issuer-Pays Rating Model and Ratings Inflation: Evidence from Corporate Credit Ratings

44 Pages Posted: 10 Feb 2012 Last revised: 22 Sep 2012

See all articles by Han Xia

Han Xia

University of Texas at Dallas - Naveen Jindal School of Management

Günter Strobl

University of Vienna - Department of Finance

Date Written: February 2012

Abstract

This paper provides evidence that the conflict of interest caused by the issuer-pays rating model leads to inflated corporate credit ratings. Comparing the ratings issued by Standard & Poor's Ratings Services (S&P) which follows this business model to those issued by the Egan-Jones Rating Company (EJR) which adopts the investor-pays model, we demonstrate that the difference between the two is more pronounced when S&P's conflict of interest is particularly severe: firms with more short-term debt, a newly appointed CEO or CFO, and a lower percentage of past bond issues rated by S&P are significantly more likely to receive a rating from S&P that exceeds their rating from EJR. However, we find no evidence that these variables are related to corporate bond yield spreads, which suggests that investors may be unaware of S&P's incentive to issue inflated credit ratings.

Keywords: Corporate credit ratings, Issuer-pays rating model, Ratings inflation

JEL Classification: D82, G24

Suggested Citation

Xia, Han and Strobl, Günter, The Issuer-Pays Rating Model and Ratings Inflation: Evidence from Corporate Credit Ratings (February 2012). Available at SSRN: https://ssrn.com/abstract=2002186 or http://dx.doi.org/10.2139/ssrn.2002186

Han Xia (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Günter Strobl

University of Vienna - Department of Finance ( email )

Oskar-Morgenstern-Platz 1
Vienna, 1090
Austria

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
1,543
Abstract Views
7,164
Rank
22,238
PlumX Metrics