Do Reputational Concerns Lead to Reliable Ratings?

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 pro ject 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.

Number of Pages in PDF File: 47

Keywords: Reputation, rating agencies, conformism, conservatism, boldness

JEL Classification: D82, G1, G24

working papers series