A countermeasure designed to restrain self-serving behavior and strategic rating disclosure of credit rating agencies

Kittiphod Charoontham, Jirawat Worakantak, Kessara Kanchanapoom and Nartraphee Tancho

Journal of Management Analytics, 2023, vol. 10, issue 3, 550-565

Abstract: This study examines an incentive of the credit rating agency (CRA) to exert effort to observe projects’ signals and strategically disclose ratings when the upfront fee and performance-based fee scheme are imposed. Under the upfront fee scheme, the CRA obtains an upfront fee in exchange for its services but gains a performance-based fee only if its ratings accurately foresee the rated project’s outcome. In the setting, an issuer solicits a rating from the CRA, whose conduct of inflating and deflating ratings is considered. In addition, the CRA can endogenously exert effort to observe a project's signal, which specifies the signal accuracy and how much operating costs the CRA incurs. After receiving the observed signal, the CRA can strategically decide to announce a rating corresponding to or contradicting the observed signal. The findings reveal that the performance-based fee scheme incentivizes the CRA to exert greater effort and truthfully disclose a more accurate rating.

Date: 2023
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DOI: 10.1080/23270012.2023.2209859

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