Can Investor-Paid Credit Rating Agencies Improve the Information Quality of Issuer-Paid Rating Agencies?

Abstract:     
This paper examines how the information quality of ratings from issuer-paid rating agencies responds to the entry of an investor-paid rating agency, the Egan-Jones Rating Company (EJR). By comparing the ratings quality of issuer-paid agencies before and after EJR initiates coverage of each given firm, we find a significant quality improvement in the ratings provided by issuer-paid agencies following EJR’s coverage: ratings become more responsive to credit risk, and rating changes become more timely. These results differ from the existing literature documenting a deterioration in incumbents’ ratings quality following the entry of a third issuer-paid agency. We further show that issuer-paid agencies do not simply respond to EJR’s coverage because they learn EJR’s information and update their ratings accordingly. Rather, EJR seems to have elevated their reputational concerns and alleviated their biased incentives resulting from the issuer-pays business model.

Number of Pages in PDF File: 67

Keywords: credit ratings, information quality, investor-pays business model, investor-paid rating agencies

JEL Classification: G14, G24, G28

working papers series