If You Misrate, then You Lose: Improving Credit Rating Accuracy Through Incentive Compensation

24 Pages Posted: 15 Jan 2010 Last revised: 19 Feb 2010

Yair Listokin

Yale Law School

Benjamin Taibleson

Yale Law School

Date Written: January 12, 2010

Abstract

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.

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

Suggested Citation

Listokin, Yair and Taibleson, Benjamin, If You Misrate, then You Lose: Improving Credit Rating Accuracy Through Incentive Compensation (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. Available at SSRN: https://ssrn.com/abstract=1535514

Yair Listokin (Contact Author)

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-436-2567 (Phone)

Benjamin Taibleson

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States

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