Credit Ratings and Competition

Abstract

I analyze a model of competition between credit rating agencies (CRAs). In equilibrium, investors only buy assets that received high ratings from multiple CRAs. This has two contrasting effects on the quality of certification. On the one hand, the issuer needs to pass the screening of multiple CRAs; other things being equal, this improves certification. On the other hand, it has the perverse effect of incentivizing dishonest ratings, by introducing a team dimension that dilutes the CRAs' reputational concerns. When the perverse effect dominates, competition reduces the quality of certification. However, mandating disclosure of indicative ratings can restore the first-best outcome.

Keywords: Credit rating agencies, Reputation, Competition

JEL Classification: G24, L14