Can Market Discipline Work in the Case of Rating Agencies? Some Lessons from Moody’s Stock Price

This paper examines whether the stock price of the rating agency Moody’s reacts negatively to rating actions that could indicate low rating quality. The reaction to rating reversals, which Moody’s describes as particularly damaging to investors, is economically significant. It suggests that market discipline has the potential to influence agency behavior. On the other hand, defaults of highly rated issuers do not consistently impact Moody’s stock price. The focus on reversals and the neglect of default events are consistent with either collusion or with misconceptions of how rating quality should be evaluated. Both interpretations question whether market discipline can be sufficient to ensure a socially optimal rating policy within the current environment. Copyright Springer Science+Business Media, LLC 2013