Credit rating and competition

Abstract

We analyze the effect of competition between credit rating agencies (RA) which trade-off reputation (future income) and rating inflation (current income). We find that relative to monopoly, RA are more likely to inflate ratings under duopoly. Moreover, competition reduces welfare (the net income of the projects that are rated good) if the new entrant has low reputation and increases it if the new entrant has high reputation. Therefore, our results suggest that lowering barriers to entry (thus, allowing low-reputation credit RA to enter the market) might increase the level of rating inflation and reduce welfare.

Impact of Competition in Credit Rating Industry: Evidence From India

“…In addition, the paper results also indicate that competition leads to a firm getting a higher initial rating from a CRA than the firm’s existing rating, resulting in rating shopping in the credit rating industry. The findings of the study are consistent with prior literature, which supports that competition among CRAs worsens the quality of credit ratings (Becker et al, 2011; Bolton et al, 2012; Camanho et al, 2022; Flynn & Ghent, 2018; Park & Lee, 2018; Vu et al, 2022).…”

“…Bolton et al (2012) used a model to analyze the impact of competition on credit rating and found that competition reduces efficiency, increases rating shopping, and could result in rating inflation. Camanho et al (2022) used a theoretical model to analyze competition among CRAs and found that competition exacerbates the problem of rating inflation in the credit rating industry. Lee and Schantl (2019) used a model to analyze how the dynamics between competition among CRAs and their gatekeeper’s role impact rating inflation in the industry.…”

“…The paper focuses on testing the presence of rating inflation and rating shopping due to competition in the credit rating industry. Several researchers have analyzed the impact of competition on credit rating, but mainly through an indirect approach using theoretical models with assumptions (Bolton et al, 2012; Camanho et al, 2022; Chu & Rysman, 2019; Lee & Schantl, 2019) or using market share data of CRAs as a proxy of competition (Bae et al, 2019; Becker et al, 2011; Flynn & Ghent, 2018; Vu et al, 2022). Existing literature on competition in the credit rating industry has primarily focused on the US (Becker et al, 2011; Flynn & Ghent, 2018; Griffin et al, 2013) and other markets such as Canada, Korea, and China (Bae et al, 2019; Chu & Rysman, 2019; Vu et al, 2022).…”

“…The Issuer-pays model is an approach where the issuer of debt pays for evaluating its securities. Several researchers have highlighted that CRAs face a conflict of interest between providing informative ratings to investors and satisfying issuers' rating preferences (Camanho et al, 2022;Cavallaro & Trotta, 2019;Mathis et al, 2009;Partnoy, 2006).…”

Research on Bond Participants’ Emotion Reactions Toward the Internet News in China’s Bond Market

“… Bhandari and Golden (2021) found that CRAs had a stronger response to CEO’s political ideology. Camanho et al (2020) revealed that CRAs tended to upgrade credit ratings when facing fierce competition in the credit rating market. However, there is little literature available for how CRAs or credit ratings react to financial news on the internet.…”