Investor-Paid Ratings and Conflicts of Interest

Leo Tang, Marietta Peytcheva and Pei Li ()
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Leo Tang: Lehigh University
Marietta Peytcheva: Lehigh University
Pei Li: Southwestern University of Finance and Economics - School of Accounting

Journal of Business Ethics, 2020, vol. 163, issue 2, No 11, 365-378

Abstract: 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 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (6)

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DOI: 10.1007/s10551-018-4042-8

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