Investor-Paid Ratings and Conflicts of Interest

32 Pages Posted: 6 Nov 2018 Last revised: 8 Nov 2018

See all articles by Leo Tang

Leo Tang

Lehigh University

Marietta Peytcheva

Lehigh University

Pei Li

Southwestern University of Finance and Economics (SWUFE)

Date Written: October 22, 2018

Abstract

The Securities and Exchange Commission (SEC) sanctioned investor-paid rating agency Egan-Jones for falsely stating that it did not know its clients’ investment positions. The SEC’s action against Egan-Jones raises the broad question whether knowledge of clients’ investment positions creates a conflict of interest for investor paid ratings. In an experimental setting, we find that investor-paid rating agencies are likely to assign credit ratings that are biased in favor of their clients’ positions, and that this effect is attenuated when the rated company has a sophisticated investor base that is expected to scrutinize ratings. The effect is not conditional on the risk profile of the rated companies. Taken together, our findings suggest that a conflict of interest stemming from investors’ preferences is likely to bias ratings under investor-pays business models, but scrutiny by the company’s investor base can counteract this bias.

Keywords: credit rating agency, investor-pays model, issuer-pays model, conflict of interest, motivated reasoning

JEL Classification: G24

Suggested Citation

Tang, Leo and Peytcheva, Marietta and Li, Pei, Investor-Paid Ratings and Conflicts of Interest (October 22, 2018). Journal of Business Ethics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3270894

Leo Tang

Lehigh University ( email )

621 Taylor St
Bethlehem, PA 18015
United States

Marietta Peytcheva

Lehigh University ( email )

621 Taylor Street
Bethlehem, PA 18015
United States
610 758 2818 (Phone)
610 758 5992 (Fax)

Pei Li (Contact Author)

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

Register to save articles to
your library

Register

Paper statistics

Downloads
38
Abstract Views
665
PlumX Metrics