Can Investor-Paid Credit Rating Agencies Improve the Information Quality of Issuer-Paid Rating Agencies?
University of Texas at Dallas - Naveen Jindal School of Management
September 16, 2013
Journal of Financial Economics (JFE), Forthcoming
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.
Number of Pages in PDF File: 69
Keywords: credit ratings, information quality, investor-pays business model, investor-paid rating agencies
JEL Classification: G14, G24, G28
Date posted: January 8, 2012 ; Last revised: October 22, 2013