Information Content of Unsolicited Credit Ratings and Incentives of Rating Agencies: A Theory

34 Pages Posted: 20 Mar 2011 Last revised: 8 Mar 2014

Date Written: July 2013

Abstract

Unsolicited credit ratings are issued solely at the discretion of rating agencies based on public information. This paper analyzes firms' incentives to solicit credit ratings to signal their quality and rating agencies' incentives to issue unsolicited ratings. Conditions for two types of equilibria are derived. When rating agencies are compensated for the accuracy of ratings under the subscriber-fee scheme, a quasi-separating equilibrium is likely to occur, in which firm quality is revealed through unsolicited ratings. When rating agencies are compensated only for solicited ratings under the issuer-fee scheme, a separating equilibrium results, in which high-quality firms signal through solicited ratings while low-quality firms are revealed through unsolicited ratings. We show that rating agencies have strong incentives to selectively issue unsolicited ratings in order to induce more fee-based solicited ratings under the issuer-fee scheme..

Keywords: Unsolicited rating; Asymmetric information; Signaling; Subscriber-fee scheme; Issuer-fee scheme

JEL Classification: G10, G14, G15

Suggested Citation

Byoun, Soku, Information Content of Unsolicited Credit Ratings and Incentives of Rating Agencies: A Theory (July 2013). International Review of Economics & Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1711808 or http://dx.doi.org/10.2139/ssrn.1711808

Soku Byoun (Contact Author)

Baylor University ( email )

Department of Finance Insurance & Real Estate
P.O.Box 98004
Waco, TX 76712
254-710-7849 (Phone)

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