Alternatives for issuer-paid credit rating agencies

Dion Bongaerts

No 1703, Working Paper Series from European Central Bank

Abstract: This paper investigates the economic viability and welfare contribution of alternatives to issuer-paid credit rating agencies (CRAs). To this end, it introduces a heterogeneous competition model for credit and ratings markets. Frictions among issuers or investors induce rating inflation from issuer-paid CRAs. Investor-paid CRAs suffer from three sources of free-riding and are generally not economically viable when competing with issuer-paid CRAs. Only for very limited parameter ranges can investor-paid CRAs thrive and counter rating inflation. Other proposed alternatives such as investor-produced ratings and CRA co-investments employ skin-in-the-game to induce proper screening accuracy. However, as traditional issuer-paid CRAs can cater better to issuers, such alternatives generate little demand or are implemented ineffectively. Hence, this paper provides an explanation for the evolution, dominance and resiliency of issuer-paid CRAs. JEL Classification: G24, G28, L14

Keywords: competition; credit rating agencies; regulation; reputation (search for similar items in EconPapers)
Date: 2014-08
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Citations: View citations in EconPapers (9)

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