The Issuer-Pays Rating Model and Ratings Inflation: Evidence from Corporate Credit Ratings

44 Pages Posted: 10 Feb 2012 Last revised: 22 Sep 2012

Han Xia

University of Texas at Dallas - Naveen Jindal School of Management

Günter Strobl

Frankfurt School of Finance & Management

Date Written: February 2012

Abstract

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.

Keywords: Corporate credit ratings, Issuer-pays rating model, Ratings inflation

JEL Classification: D82, G24

Suggested Citation

Xia, Han and Strobl, Günter, The Issuer-Pays Rating Model and Ratings Inflation: Evidence from Corporate Credit Ratings (February 2012). Available at SSRN: https://ssrn.com/abstract=2002186 or http://dx.doi.org/10.2139/ssrn.2002186

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

Günter Strobl

Frankfurt School of Finance & Management ( email )

Sonnemannstraße 9-11
Frankfurt am Main, 60314
Germany

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