Regulating Credit Rating Agencies

Regulating Credit Rating Agencies

Elgar Financial Law series

Aline Darbellay

This highly topical book examines how the leading credit rating agencies – Moody's, Standard & Poor’s and Fitch – have risen to prominence in the wake of the financial crisis.

Chapter 8: Wrong incentives in the credit rating industry

Aline Darbellay

Subjects: law - academic, finance and banking law


CRAs’ conflicts of interest are particularly acute in the structured finance segment. Since the 1970s the rating industry has shifted from an investor-pays business model to an issuer-pays business model. CRAs could no longer count on investors to pay for credit ratings. This is partly based on the fact that information is a public good. Due to the public-good nature of ratings, it is hard to get any individual investor to pay for ratings. It is worth mentioning that communication technology has changed dramatically since the creation of the rating industry in 1909. Above all, since the 1970s, low-cost photocopying explains why investors are not willing to pay for information that can easily be spread. Information economics theory highlights the fact that ratings are hard to sell to investors. The equilibrium selling price for rating information is zero. In fact, each recipient of a rating could secretly sell the information to other investors for a somewhat lower price until the price for the rating information falls to zero. From another perspective, less reliance on the CRAs to provide valuable information may partly have moved investors away from ratings. In order to be profitable, CRAs had to rely on another source of revenue and they started being paid by the issuers. Accordingly, in modern financial markets one reason for CRAs’ profitability is the issuers’ strong demand for ratings. Currently, conflicts of interest have been particularly acute since the vast majority of the leading CRAs’ revenues are from issuers’ fees.

You are not authenticated to view the full text of this chapter or article.

Elgaronline requires a subscription or purchase to access the full text of books or journals. Please login through your library system or with your personal username and password on the homepage.

Non-subscribers can freely search the site, view abstracts/ extracts and download selected front matter and introductory chapters for personal use.

Your library may not have purchased all subject areas. If you are authenticated and think you should have access to this title, please contact your librarian.

Further information