Evaluating Proposed Remedies for Credit Rating Agency Failures: Improving Independence and Justifying Departures from Quantitative Credit Rating Models

46 Pages Posted: 13 Mar 2013

See all articles by S. Jane Kennedy Jollineau

S. Jane Kennedy Jollineau

University of San Diego - School of Business; University of San Diego - Department of Accountancy; University of Washington - Foster School of Business

Lloyd Tanlu

Washington and Lee University; University of Washington - Department of Accounting; Northeastern University

Amanda Winn

University of Illinois at Urbana-Champaign

Date Written: December 15, 2012

Abstract

The overly optimistic debt ratings provided by credit rating agencies (CRAs) and the lack of transparency about the rating process have been criticized by regulators and pundits for exacerbating the financial crisis. We conduct a mixed-design experiment exploring how two proposals advanced by lawmakers affect the behavior of credit rating analysts. Using data taken from personal lending site Prosper.com, we examine whether (a) the requirement to justify departures from a quantitative model, and (b) conflicts of interests stemming from who pays the analysts affect rating characteristics. We then examine how justifying departures in turn influences the conflicts of interest faced by credit raters. We find that justifying departures reduces the likelihood that credit raters deviate from a quantitative model. Furthermore, credit raters who are not required to justify departures from the model tend to depart from the model in a direction that benefits the borrower, but only in the “borrower pays” condition. Additionally, credit raters facing conflict of interest appear to behave strategically and are less willing to lend their own money to borrowers, even if these credit raters assign more favorable ratings to these same borrowers. This study complements the existing archival literature on credit rating agencies and the conflicts of interest facing these agencies. Results of this study may inform regulators regarding the effectiveness of the different proposals on CRA reform.

Suggested Citation

Kennedy Jollineau, S. Jane and Tanlu, Lloyd D. and Winn, Amanda, Evaluating Proposed Remedies for Credit Rating Agency Failures: Improving Independence and Justifying Departures from Quantitative Credit Rating Models (December 15, 2012). Available at SSRN: https://ssrn.com/abstract=2230535 or http://dx.doi.org/10.2139/ssrn.2230535

S. Jane Kennedy Jollineau (Contact Author)

University of San Diego - School of Business ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States
619.260.2766 (Phone)

University of San Diego - Department of Accountancy ( email )

223 Olin Hall
5998 Alcalá Park
San Diego, CA
United States

HOME PAGE: http://https://www.sandiego.edu/business/directory/biography.php?_focus=1238

University of Washington - Foster School of Business ( email )

Seattle, WA 98195-3226
United States
206-543-4368 (Phone)
206-685-9392 (Fax)

Lloyd D. Tanlu

Washington and Lee University ( email )

Lexington, VA 24450
United States

University of Washington - Department of Accounting ( email )

224 Mackenzie Hall, Box 353200
Seattle, WA 98195-3200
United States

Northeastern University ( email )

360 Huntington Ave.
Boston, MA 02115
United States

Amanda Winn

University of Illinois at Urbana-Champaign ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
165
Abstract Views
1,287
rank
178,197
PlumX Metrics