Detecting conflicts of interest in credit rating changes: a distribution dynamics approach

Abstract

In this study, we compare the adjustments of credit ratings by an investor-paid credit rating agency (CRA), represented by Egan-Jones Ratings Company, and an issuer-paid CRA, represented by Moody’s Investors Service, vis-à-vis conflict of interest and reputation. A novel distribution dynamics approach is employed to compute the probability distribution and, hence, the downgrade and upgrade probabilities of a credit rating assigned by these two CRAs of different compensation systems based on the dataset of 750 U.S. issuers between 2011 and 2018, that is, after the passage of the Dodd–Frank Act. It is found that investor-paid ratings are more likely to be downgraded than issuer-paid ratings only in the lower rating grades, which is consistent with the argument that investor-paid agencies have harsher attitudes toward potentially defaulting issuers to protect their reputation. We do not find evidence that issuer-paid CRAs provide overly favorable treatments to issuers with threshold ratings, implying that reputation concerns and the Dodd–Frank regulation mitigate the conflict of interests, while issuer-paid CRAs are more concerned about providing accurate ratings.

Transitional dynamics and the evolution of information transparency: a global analysis

“…The dataset is first divided into three episodes, namely, 1980-1990, 1990-2000, and 2000-2010, i.e., there are 10 annual transitions in each episode. Given that similar cultural values can often be observed across countries situated close to each other, the division according to geographic regions can provide vital information on the development of IT 6 This method has been recently employed in various research areas, such as in industrialization (Cheong and Wu, 2018), electricity consumption (Cheong et al, 2019) and even credit ratings (Lee et al, 2021). across different cultural settings.…”

The impact of working capital management on credit rating

“…Credit-rating agencies play a vital role in capital markets by reducing the moral hazard problem. In addition, credit ratings help investors assess the creditworthiness of issuers and the financial securities issued by them (Lee et al 2021). Furthermore, credit ratings are used as a benchmark based on which investors manage their portfolios.…”