Are Investor-paid Credit Ratings Superior?

Abstract

We conduct pairwise comparisons of corporate bond ratings between three issuer-paid credit rating agencies (CRAs) and one investor-paid CRA regarding rating standard, accuracy, stability, and market impact. We find that neither compensation model results in more stringent or accurate ratings. While issuer-paid S&P ratings are more stringent and accurate than investor-paid Egan-Jones ratings (EJR), issuer-paid Fitch ratings are less stringent and have similar or lower accuracy compared to EJR ratings. In contrast, investor- and issuer-paid ratings exhibit different rating change behaviors. EJR updates its ratings more frequently with fewer multi-notch downgrades but also has a higher likelihood of rating reversals, while rating change behaviors are similar among the three issuer-paid CRAs. Finally, issuer-paid rating changes trigger stronger market responses.

Keywords: Corporate bonds, credit ratings, rating standards, discriminatory power, rating stability, market impact

JEL Classification: G14, G20, G24, G28