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Non-rating revenue and conflicts of interest

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  • Becker, Bo
  • Baghai, Ramin

Abstract

Rating agencies produce ratings used by investors, but obtain most of their revenue from issuers, leading to a conflict of interest. We employ a detailed panel data set on the use of non-rating services, and the associated payments, in India, to test to what extent this conflict affects credit ratings. Rating agencies rate issuers that hire them for non-rating services 0.3 notches higher (than agencies that are not hired for such services). Also, within rating categories, default rates are higher for firms that have paid for non-rating services. Both these effects are larger the larger the amount paid for non-rating services is. These results suggest that issuers which hire agencies for consulting services receive higher ratings despite not having lower credit risk.

Suggested Citation

  • Becker, Bo & Baghai, Ramin, 2016. "Non-rating revenue and conflicts of interest," CEPR Discussion Papers 11508, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:11508
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    2. Krishnan, Kaveri & Mukherji, Arnab & Basu, Sankarshan, 2020. "Market responses to increased transparency: An Indian narrative," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 663-677.
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    4. Bonsall, Samuel B. & Gillette, Jacquelyn R. & Pundrich, Gabriel & So, Eric, 2024. "Conflicts of interest in subscriber-paid credit ratings," Journal of Accounting and Economics, Elsevier, vol. 77(1).
    5. Terovitis, Spyros, 2022. "Information disclosure and the feedback effect in capital markets," Journal of Financial Intermediation, Elsevier, vol. 49(C).
    6. Bo Becker & Marcus M Opp & Farzad Saidi, 2022. "Regulatory Forbearance in the U.S. Insurance Industry: The Effects of Removing Capital Requirements for an Asset Class," The Review of Financial Studies, Society for Financial Studies, vol. 35(12), pages 5438-5482.
    7. Wai Choi Lee & Jianfu Shen & Tsun Se Cheong & Michal Wojewodzki, 2021. "Detecting conflicts of interest in credit rating changes: a distribution dynamics approach," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-23, December.
    8. Abidi, Nordine & Falagiarda, Matteo & Miquel-Flores, Ixart, 2023. "Quantitative easing and credit rating agencies," International Review of Financial Analysis, Elsevier, vol. 86(C).
    9. Guneren Genc, Elif & Deniz Basar, Ozlem, 2019. "Comparison of Country Ratings of Credit Rating Agencies with MOORA Method," Business and Economics Research Journal, Uludag University, Faculty of Economics and Administrative Sciences, vol. 10(2), pages 391-404, April.
    10. Nguyen, Quan M.P. & Do, Hung Xuan & Molchanov, Alexander & Nguyen, Lily & Nguyen, Nhut H., 2023. "Political similarities in credit ratings," International Review of Financial Analysis, Elsevier, vol. 86(C).
    11. Basu, Kaushik & Sun, Haokun, 2022. "The power and influence of rating agencies with insights into their misuse," Economic Modelling, Elsevier, vol. 109(C).
    12. Hung, Mingyi & Kraft, Pepa & Wang, Shiheng & Yu, Gwen, 2022. "Market power and credit rating standards: Global evidence," Journal of Accounting and Economics, Elsevier, vol. 73(2).
    13. Bae, Kee-Hong & Driss, Hamdi & Roberts, Gordon S., 2019. "Does competition affect ratings quality? Evidence from Canadian corporate bonds," Journal of Corporate Finance, Elsevier, vol. 58(C), pages 605-623.
    14. Vu, Huong & Alsakka, Rasha & ap Gwilym, Owain, 2022. "Does competition improve sovereign credit rating quality?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 76(C).
    15. Krystyniak, Karolina & Staneva, Viktoriya, 2024. "The myth of tightening credit rating standards in the market for corporate debt," Journal of Banking & Finance, Elsevier, vol. 162(C).
    16. Zhao, Sheng & Moreira, Fernando & Wang, Tong, 2021. "Is solicitation status related to rating conservatism and rating quality?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 72(C).
    17. Andreas G. F. Hoepner & Savio Dimatteo & Joe Schauld & Pei-Shan Yi & Mirco Musolesi, 2017. "Tweeting About Sustainability: Can Emotional Nowcasting Discourage Greenwashing?," ICMA Centre Discussion Papers in Finance icma-dp2017-02, Henley Business School, University of Reading.
    18. Darmouni, Olivier & Papoutsi, Melina, 2022. "The rise of bond financing in Europe: five facts about new and small issuers," Working Paper Series 2663, European Central Bank.
    19. Jarosław Brożek & Anna Kożuch & Marek Wieruszewski & Roman Jaszczak & Krzysztof Adamowicz, 2024. "Taxonomy Regulation as a New Instrument for the Sustainable Management of the Forest Environment in Europe," Sustainability, MDPI, vol. 16(20), pages 1-20, October.
    20. Samuel B. Bonsall & Kevin Koharki & Pepa Kraft & Karl A. Muller & Anywhere Sikochi, 2023. "Do Rating Agencies Behave Defensively for Higher Risk Issuers?," Management Science, INFORMS, vol. 69(8), pages 4864-4887, August.
    21. Becker, Bo & Opp, Marcus & Saidi, Farzad, 2020. "Regulatory Forbearance in the U.S. Insurance Industry: The Effects of Eliminating Capital Requirements," CEPR Discussion Papers 14373, C.E.P.R. Discussion Papers.
    22. Martijn Boermans & Bram van der Kroft, 2020. "Capital regulation induced reaching for systematic yield: Financial instability through fire sales," Working Papers 673, DNB.
    23. John M Griffin & Jordan Nickerson, 2023. "Are CLO Collateral and Tranche Ratings Disconnected?," The Review of Financial Studies, Society for Financial Studies, vol. 36(6), pages 2319-2360.
    24. A. Talha Yalta & Yasemin Yalta, 2018. "Are the Credit Rating Agencies Biased Against MENA Countries?," Working Papers 1274, Economic Research Forum, revised 19 Dec 2018.
    25. Yalta, A. Talha & Yalta, A. Yasemin, 2018. "Are credit rating agencies regionally biased?," Economic Systems, Elsevier, vol. 42(4), pages 682-694.

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    More about this item

    Keywords

    Credit ratings; Agency problems; Issuer-pays;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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