If You Misrate, then You Lose: Improving Credit Rating Accuracy Through Incentive Compensation
Yale Law School
Yale Law School
January 12, 2010
Yale Journal on Regulation, January 2010
Yale Law School, Public Law Working Paper No. 203
Yale Law & Economics Research Paper No. 402
Credit rating agencies (CRAs) serve many roles in maintaining properly functioning debt markets. Their contribution to both Enron-era financial scandals and the 2008-2010 financial crisis, however, has led to many calls for credit rating reform. This Essay proposes an incentive compensation scheme in which CRAs are paid with the debt they rate. If a CRA overrates debt, then the CRA suffers a financial penalty because the debt the CRA receives as compensation is less valuable than the cash compensation that the debt is replacing. We believe that this reform, though imperfect, would be more likely to generate accurate ratings than other credit rating reform proposals. We also discuss extensions of our basic debt compensation proposal that mitigate some of debt compensation’s weaknesses, though at the cost of greater complexity.
Number of Pages in PDF File: 24
Keywords: credit rating, credit rating agencies, law, law and economics, corporate law, corporate finance, law and finance, securities regulation, bankruptcy, incentive compensation
JEL Classification: K2, K00, K22, K20, L5, G33, G32, G3, G3, G38
Date posted: January 15, 2010 ; Last revised: February 19, 2010
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