The Performance Disclosures of Credit Rating Agencies: Are They Effective Reputational Sanctions?

Abstract

The SEC has recently added new provisions to the credit rating agency regulation. These provisions require credit rating agencies to disclose publicly their rating actions and performance measurements. The new requirements seek to achieve two goals: (1) deter conflicts of interest in the credit rating industry by invoking the reputational sanction power of performance statistics, and (2) help new entrants to the industry build a track record so they can compete with established agencies. This paper reveals empirical evidence that the current disclosure requirements cannot achieve these goals and makes recommendations on how the regulation should be improved in light of consumer choice research and cognitive science findings on effective communication.

Keywords: credit rating agency, disclosure, conflict of interest, reputational sanction

JEL Classification: K2, C1