Race to the Top: Credit Rating Bias from Competition

Posted: 2 Jul 2015 Last revised: 3 Jul 2015

See all articles by Yun Wang

Yun Wang

Renmin University of China

Yilan Xu

University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics

Date Written: May 13, 2015

Abstract

Empirical studies have found that competition among credit-rating agencies (CRAs) deteriorates the quality of ratings. We provide a game theoretical framework to analyze CRA competition in the context of conflict of interest. We show that conflict of interest distorts the rating: the rating inflation increases as the publication fee offered by the issuer increases. As the degree of competition increases, the rating deviates even more and investors' utility declines. If the CRAs can publish unsolicited ratings, the rating inflation decreases with the degree of competition, and investors' utility improves over the solicited system. If the CRAs are paid by a third party, all CRAs truthfully report their ratings and investors' utility further improves.

Keywords: information bias, competition, credit rating shopping, conflict of interest, solicited rating, unsolicited rating

Suggested Citation

Wang, Yun and Xu, Yilan, Race to the Top: Credit Rating Bias from Competition (May 13, 2015). Available at SSRN: https://ssrn.com/abstract=2625404

Yun Wang (Contact Author)

Renmin University of China ( email )

China
01082500299 (Phone)
100872 (Fax)

Yilan Xu

University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics ( email )

309 Mumford Hall
Urbana, IL 61801
United States

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