Who Should Pay for Credit Ratings and How?

We analyze a model where investors use a credit rating to decide whether to finance a firm. The rating quality depends on unobservable effort exerted by a credit rating agency (CRA). We study optimal compensation schemes for the CRA when a planner, the firm, or investors order the rating. Rating err...

Full description

Saved in:
Bibliographic Details
Published in:The Review of financial studies 2016-02, Vol.29 (2), p.420-456
Main Authors: Kashyap, Anil K., Kovrijnykh, Natalia
Format: Article
Language:English
Subjects:
Business entities
Compensation
Credit rating
Credit ratings
Economic crises
Fees
Finance
Financial securities
Interest rates
Investors
Rating services
Return on investment
Studies
Total surplus
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:We analyze a model where investors use a credit rating to decide whether to finance a firm. The rating quality depends on unobservable effort exerted by a credit rating agency (CRA). We study optimal compensation schemes for the CRA when a planner, the firm, or investors order the rating. Rating errors are larger when the firm orders it than when investors do (and both produce larger errors than is socially optimal). Investors overuse ratings relative to the firm or planner. A trade-off in providing time-consistent incentives embedded in the optimal compensation structure makes the CRA slow to acknowledge mistakes.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhv127