Race to the Top: Credit Rating Bias from Competition
Posted: 2 Jul 2015 Last revised: 3 Jul 2015
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: Suggested Citation