Rating Agencies in the Face of Regulation

33 Pages Posted: 26 Jan 2010 Last revised: 11 Aug 2020

See all articles by Christian C. Opp

Christian C. Opp

University of Rochester - Simon Business School; National Bureau of Economic Research (NBER)

Marcus M. Opp

Stockholm School of Economics - Department of Finance; Swedish House of Finance

Milton Harris

University of Chicago - Finance

Date Written: September 19, 2012

Abstract

This paper develops a theoretical framework to shed light on variation in credit rating standards over time and across asset classes. Ratings issued by credit rating agencies serve a dual role: they provide information to investors and are used to regulate institutional investors. We show that introducing rating-contingent regulation that favors highly rated securities may increase or decrease rating informativeness, but unambiguously increases the volume of highly rated securities. If the regulatory advantage of highly rated securities is sufficiently large, delegated information acquisition is unsustainable, since the rating agency prefers to facilitate regulatory arbitrage by inflating ratings. Our model relates rating informativeness to the quality distribution of issuers, the complexity of assets, and issuers' outside options. We reconcile our results with the existing empirical literature and highlight new, testable implications, such as repercussions of the Dodd-Frank Act.

Keywords: Financial Regulation, Rating Agencies, Certification, Dodd-Frank Act

JEL Classification: G24, G28, G01, D82, D83

Suggested Citation

Opp, Christian C. and Opp, Marcus M. and Harris, Milton, Rating Agencies in the Face of Regulation (September 19, 2012). Journal of Financial Economics (JFE), Vol. 108, pp. 64-81, 2013, Chicago Booth Research Paper No. 13-05, Fama-Miller Working Paper, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=1540099 or http://dx.doi.org/10.2139/ssrn.1540099

Christian C. Opp

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Marcus M. Opp (Contact Author)

Stockholm School of Economics - Department of Finance ( email )

SE-113 83 Stockholm
Sweden

Swedish House of Finance

Drottninggatan 98
111 60 Stockholm
Sweden

Milton Harris

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
(773) 702-2549 (Phone)
(773) 753-8310 (Fax)

HOME PAGE: http://faculty.chicagobooth.edu/milton.harris/

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