The Economics of Investor-Paid Credit Rating Agencies

48 Pages Posted: 27 Jun 2019

See all articles by Dion Bongaerts

Dion Bongaerts

Erasmus University Rotterdam (EUR) - Finance

Date Written: June 20, 2019

Abstract

I model direct competition between investor-paid and issuer-paid credit rating agencies (CRAs). Frictions in the form of issuer private benefits induce issuer-paid CRAs to inflate ratings. Investor-paid CRAs optimally generate more accurate ratings, leading to adverse selection for investors that do not purchase these ratings. Yet, rating fees being sunk costs for investors, the endogenous response of issuers and issuer-paid CRAs, and endogenous free-riding by other investors prevent investor-paid ratings from dominating in equilibrium. Consequently, producing investor-paid ratings reduces welfare due to redundant information production. My results conform to several empirical regularities.

Keywords: Credit Rating Agencies, Competition, Regulation, Investor-Paid

JEL Classification: G24, G28, L14

Suggested Citation

Bongaerts, Dion, The Economics of Investor-Paid Credit Rating Agencies (June 20, 2019). Available at SSRN: https://ssrn.com/abstract=3409690 or http://dx.doi.org/10.2139/ssrn.3409690

Dion Bongaerts (Contact Author)

Erasmus University Rotterdam (EUR) - Finance ( email )

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