Rating Agencies in the Face of Regulation

33 Pages Posted: 26 Jan 2010 Last revised: 11 Apr 2013

Christian C. Opp

University of Pennsylvania - The Wharton School

Marcus M. Opp

University of California, Berkeley - Finance Group

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. Available at SSRN: https://ssrn.com/abstract=1540099 or http://dx.doi.org/10.2139/ssrn.1540099

Christian C. Opp

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-573-3186 (Phone)

Marcus M. Opp (Contact Author)

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States

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/

Paper statistics

Downloads
2,926
Rank
2,827
Abstract Views
13,104