Can a Platform-Pays Mechanism Reduce Credit Ratings Bias?

37 Pages Posted: 1 Sep 2014 Last revised: 16 Mar 2019

See all articles by Indraneel Chakraborty

Indraneel Chakraborty

University of Miami

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Malcolm Wardlaw

University of Michigan, Stephen M. Ross School of Business; University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: March 12, 2019

Abstract

We show that a platform-pays mechanism can address ratings inflation and ratings shopping with minimum regulatory oversight. While we focus on ratings industry, the mechanism also applies to a setting where firms seek unbiased reports from external auditors. The mechanism has two necessary and sufficient features: strategic delegation and outcome-contingent contracts. First, an issuer strategically delegates the task to acquire ratings from credit ratings agencies (CRAs) to a pass-through non-monitoring platform (the "trust"). The trust operates as a commitment mechanism, assuring investors that issuers did not shop for ratings. Second, the ex-ante determined publicly available fees schedule is partially outcome-contingent, allowing most of the fees to be paid upfront. We provide the contractual space of fees that support the unbiased ratings equilibrium. A contract calibrated to data shows that the cost of implementation of such a mechanism is small. Results encourage policymakers to undertake reforms.

Keywords: Platform-Pays, Ratings Inflation, Ratings Shopping, Rating Agencies

JEL Classification: D82, G14, G24, G28

Suggested Citation

Chakraborty, Indraneel and Saretto, Alessio and Wardlaw, Malcolm, Can a Platform-Pays Mechanism Reduce Credit Ratings Bias? (March 12, 2019). Available at SSRN: https://ssrn.com/abstract=2489471 or http://dx.doi.org/10.2139/ssrn.2489471

Indraneel Chakraborty

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
312-208-1283 (Phone)

HOME PAGE: http://sites.google.com/site/chakraborty/

Alessio Saretto (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)

HOME PAGE: http://www.utdallas.edu/~axs125732

Malcolm Wardlaw

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States
972-883-5903 (Phone)

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