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http://ssrn.com/abstract=2239724
 
 

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Who Should Pay for Credit Ratings and How?


Anil K. Kashyap


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Natalia Kovrijnykh


Arizona State University (ASU) - Economics Department

March 1, 2013

Chicago Booth Research Paper No. 13-38
Fama-Miller Working Paper

Abstract:     
This paper analyzes a model where investors use a credit rating to decide whether to finance a firm. The rating quality depends on the unobservable effort exerted by a credit rating agency (CRA). We analyze optimal compensation schemes for the CRA that differ depending on whether a social planner, the firm, or investors order the rating. We find that rating errors are larger when the firm orders it than when investors do. However, investors ask for ratings inefficiently often. Which arrangement leads to a higher social surplus depends on the agents' prior beliefs about the project quality. We also show that competition among CRAs causes them to reduce their fees, put in less effort, and thus leads to less accurate ratings. Rating quality also tends to be lower for new securities. Finally, we and that optimal contracts that provide incentives for both initial ratings and their subsequent revisions can lead the CRA to be slow to acknowledge mistakes.

Number of Pages in PDF File: 42

Keywords: Ratings Agencies, Optimal Contracts, Moral Hazard, Information Acquisition

JEL Classification: D82, D83, D86, G24

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Date posted: March 27, 2013 ; Last revised: February 17, 2014

Suggested Citation

Kashyap, Anil K. and Kovrijnykh, Natalia, Who Should Pay for Credit Ratings and How? (March 1, 2013). Chicago Booth Research Paper No. 13-38; Fama-Miller Working Paper . Available at SSRN: http://ssrn.com/abstract=2239724 or http://dx.doi.org/10.2139/ssrn.2239724

Contact Information

Anil K. Kashyap (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7260 (Phone)
773 702-0458 (Fax)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
773-702-7260 (Phone)
773-702-0458 (Fax)
Natalia Kovrijnykh
Arizona State University (ASU) - Economics Department ( email )
Tempe, AZ 85287-3806
United States
HOME PAGE: http://www.public.asu.edu/~nkovrijn
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