Financial Reporting and Credit Ratings: On the Effects of Competition in the Rating Industry and Rating Agencies' Gatekeeper Role

Journal of Accounting Research

63 Pages Posted: 7 Jun 2018 Last revised: 14 Jun 2023

See all articles by Kyungha Lee

Kyungha Lee

Rutgers Business School at Newark & New Brunswick

Stefan Schantl

The University of Melbourne - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: March 7, 2019

Abstract

This paper studies firms' financial reporting incentives in the presence of strategic credit rating agencies and how these incentives are affected by the level of competition in the rating industry and by rating agencies' role as gatekeepers to debt markets. We develop a model featuring an entrepreneur who seeks project financing from a perfectly competitive debt market. After publicly disclosing a financial report, the entrepreneur can purchase credit ratings from rating agencies that strategically choose their rating fees and rating inflation. We derive the following core results. (i) More rating industry competition leads to stronger corporate misreporting incentives if ratings are sufficiently precise or if rating agencies assume a gatekeeper role. Under imperfect rating industry competition, (ii) agencies' gatekeeper role primarily weakens firms' misreporting incentives, which then influences rating agencies' strategies, and (iii) firms' misreporting and rating agencies' rating inflation can be strategic complements when agencies assume a gatekeeper role. (iv) Regulatory initiatives aimed at increasing rating industry competition or at weakening rating agencies' gatekeeper role improve investment efficiency as long as corporate misreporting incentives are not significantly strengthened.

Keywords: corporate disclosure, credit rating, rating inflation, investor regulation, competition

JEL Classification: D80, G12, G24, G28, M41

Suggested Citation

Lee, Kyungha (Kari) and Schantl, Stefan, Financial Reporting and Credit Ratings: On the Effects of Competition in the Rating Industry and Rating Agencies' Gatekeeper Role (March 7, 2019). Journal of Accounting Research, Available at SSRN: https://ssrn.com/abstract=3177465 or http://dx.doi.org/10.2139/ssrn.3177465

Kyungha (Kari) Lee

Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

Stefan Schantl (Contact Author)

The University of Melbourne - Department of Accounting ( email )

Victoria
Melbourne, Victoria 3010 3010
Australia

HOME PAGE: http://sites.google.com/view/stefan-f-schantl

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