Can Investor-Paid Credit Rating Agencies Improve the Information Quality of Issuer-Paid Rating Agencies?

69 Pages Posted: 8 Jan 2012 Last revised: 22 Oct 2013

Han Xia

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: September 16, 2013

Abstract

This paper examines how the information quality of ratings from an issuer-paid rating agency (Standard and Poor’s) responds to the entry of an investor-paid rating agency, the Egan-Jones Rating Company (EJR). By comparing S&P’s ratings quality before and after EJR initiates coverage of each firm, we find a significant improvement in S&P’s ratings quality following EJR’s coverage initiation. S&P’s ratings become more responsive to credit risk and its rating changes incorporate higher information content. These results differ from the existing literature documenting a deterioration in the incumbents’ ratings quality following the entry of a third issuer-paid agency. We further show that the issuer-paid agency does not simply improve its ratings quality because it learns (mimics) EJR’s information. Rather, it seems to improve the ratings quality because EJR’s coverage has elevated its reputational concerns.

Keywords: credit ratings, information quality, investor-pays business model, investor-paid rating agencies

JEL Classification: G14, G24, G28

Suggested Citation

Xia, Han, Can Investor-Paid Credit Rating Agencies Improve the Information Quality of Issuer-Paid Rating Agencies? (September 16, 2013). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1981516 or http://dx.doi.org/10.2139/ssrn.1981516

Han Xia (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

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