Testing Conflicts of Interest at Bond Rating Agencies with Market Anticipation: Evidence that Reputation Incentives Dominate

37 Pages Posted: 5 Mar 2004

See all articles by Daniel M. Covitz

Daniel M. Covitz

Board of Governors of the Federal Reserve System

Paul Harrison

Federal Reserve Board - Division of Research & Statistics

Date Written: December 2003

Abstract

This paper presents the first comprehensive test of whether well-known conflicts of interest at bond rating agencies importantly influence their actions. This hypothesis is tested against the alternative that rating agency actions are primarily influenced by a countervailing incentive to protect their reputations as delegated monitors. These two hypotheses generate a number of testable predictions regarding the anticipation of credit-rating downgrades by the bond market, which we investigate using a new data set of about 2,000 credit rating migrations from Moody's and Standard & Poor's, and matching issuer-level bond prices. The findings strongly indicate that rating changes do not appear to be importantly influenced by rating agency conflicts of interest but, rather, suggest that rating agencies are motivated primarily by reputation-related incentives.

Keywords: Rating agencies, bond market, conflicts of interest, reputation

JEL Classification: G21, G28, G32, G31

Suggested Citation

Covitz, Daniel M. and Harrison, Paul, Testing Conflicts of Interest at Bond Rating Agencies with Market Anticipation: Evidence that Reputation Incentives Dominate (December 2003). Available at SSRN: https://ssrn.com/abstract=512402 or http://dx.doi.org/10.2139/ssrn.512402

Daniel M. Covitz (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Paul Harrison

Federal Reserve Board - Division of Research & Statistics ( email )

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202-452-3819 (Fax)

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