DP14735 Advertisement-Financed Credit Ratings

Author(s): Heidrun C. Hoppe-Wewetzer, Christian Siemering
Publication Date: May 2020
Keyword(s): advertisement, Credit rating agencies, Information Acquisition, rating precision, reputation
JEL(s): D82, G24, L15
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14735

This paper investigates the incentives of a credit rating agency (CRA) to generate accurate ratings under an advertisement-based business model. We study a two-period endogenous reputation model in which the CRA can choose to provide private effort in evaluating financial products in each period. We show that the advertisement-based business model may provide sufficient incentives to improve the precision of signals when the CRA has an intermediate reputation. Furthermore, we identify conditions under which truthful reporting is incentive compatible.