The Issuer-Pays Rating Model and Ratings Inflation: Evidence from Corporate Credit Ratings
University of Texas at Dallas - Naveen Jindal School of Management
Frankfurt School of Finance & Management
This paper provides evidence that the conflict of interest caused by the issuer-pays rating model leads to inflated corporate credit ratings. Comparing the ratings issued by Standard & Poor's Ratings Services (S&P) which follows this business model to those issued by the Egan-Jones Rating Company (EJR) which adopts the investor-pays model, we demonstrate that the difference between the two is more pronounced when S&P's conflict of interest is particularly severe: firms with more short-term debt, a newly appointed CEO or CFO, and a lower percentage of past bond issues rated by S&P are significantly more likely to receive a rating from S&P that exceeds their rating from EJR. However, we find no evidence that these variables are related to corporate bond yield spreads, which suggests that investors may be unaware of S&P's incentive to issue inflated credit ratings.
Number of Pages in PDF File: 44
Keywords: Corporate credit ratings, Issuer-pays rating model, Ratings inflation
JEL Classification: D82, G24
Date posted: February 10, 2012 ; Last revised: September 22, 2012