DP11508 Non-rating revenue and conflicts of interest

Author(s): Ramin P. Baghai, Bo Becker
Publication Date: September 2016
Keyword(s): agency problems, Credit ratings, issuer-pays
JEL(s): G20, G24, G28
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11508

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.