Looking at Credit-Rating Agencies Through a Leegin Lens

Abstract

In a 2007 memorandum, Raymond McDaniel, the Chairman and CEO of Moody’s Corp., suggested that competition among credit-rating agencies does not promote ratings quality but may in fact penalize it. The basic claim here — that there are fundamental problems with competition in the credit-rating business if we care about ratings accuracy — is supported by financial research. Bo Becker and Todd Milbourn have provided evidence that the entry of Fitch as a third credit-rating agency in the market actually led to less accurate ratings. This short essay argues that this is a failure of competition only if we view the goal of competition as producing accurate ratings. If the goal of competition among credit-rating agencies is to make them serve the needs of their customers, competition appears to be working.

The customers who pay for ratings are the issuers of securities and, as McDaniel suggests, those issuers want higher ratings, not more accurate ratings.