VoxEU Column Financial Markets Financial Regulation and Banking

Possible bias in ratings when rating agencies perform consulting services

Excessively high credit ratings are thought to have contributed to the Global Crisis. A key concern is the conflict of interest that arises due to rating agencies being mainly paid by the companies whose securities they rate. This column uses Indian data to explore how the commercial ties between issuers and raters affect ratings. The results indicate a fee-driven conflict of interest, with an upward bias in the ratings of issuers whose fees are important to an agency. This highlights the potential benefits for the financial system of circumscribing rating agency consulting.

Credit ratings are a key technology in the financial system. Contracts, investment mandates, capital requirements, regulations, and loan pricing all rely on the ratings assigned by rating agencies. While ratings have been in use for more than a century, the production of ratings has been subject to more regulatory scrutiny in the period since the recent financial crisis than ever before. For example, ratings were a focus of the Dodd–Frank Wall Street Reform and Consumer Protection Act in the US; similarly, the European Parliament passed extensive regulation on credit rating agencies in 2009, and the European Securities and Markets Authority (ESMA) was set up in 2011 as the single direct supervisor of rating agencies within the EU.

Underlying these reform efforts is the understanding that excessively high credit ratings contributed to the financial crisis in 2008-2009, and that the problem was related to short-term commercial interests of rating agencies (Benmelech and Dlugosz 2009). Rating agencies are mainly paid by the companies whose securities they rate. These companies benefit from favourable (i.e. high) ratings for them or their securities. Therefore, the compensation arrangement leads to a conflict of interest between producers of ratings (the agencies) and users of ratings (such as investors). The heart of the problem is the flow of money from issuers to raters.

Regulators have recently expressed additional concerns about the provision of non-rating services by rating agencies. These high-margin, high-growth services take the form of various kinds of consulting and ancillary advice related to risk management, debt restructuring, regulation, and credit risk. For example, in a 2013 report to Congress, the SEC writes:

“[…] an NRSRO might issue a more favourable than warranted credit rating to an issuer or other party in order to obtain ancillary services business from them, or an issuer that purchases a large amount of ancillary services could pressure the NRSRO to issue a more favourable than warranted rating on that issuer.” (SEC 2013)

Similarly, the European Commission writes in 2008:

Should these non-rating services give rise to significant, high-margin revenues from a rated client, a CRA has a clear incentive to continue this lucrative relationship and look more favourably at the client's creditworthiness for rating purposes.” (EC 2008)

In a recent paper, we examine the provision of consulting services by raters, as well as the flow of payments between rated issuers and the agencies that issue ratings (Baghai and Becker 2016). We exploit previously untapped data reported by Indian rating agencies – including local subsidiaries of S&P, Moody’s, and Fitch – under regulation that took effect in 2010.1 These data provide a detailed snapshot of the commercial ties between issuers and raters, including information on payments for non-rating services.

In a sample of ratings issued between the introduction of the reporting requirements in 2010 and the latter half of 2015, we compare ratings levels for a given issuer, across agencies (see our paper for details on our methodology). We find evidence of a small apparent bias favouring issuers which generate more business for an agency: rating agencies rate issuers that hire them for non-rating services 0.3 notches higher than agencies that are not hired for such services by the same issuers. Among consulting clients, there is also a tendency for those issuers that generate larger revenues to have higher ratings (again, relative to ratings from agencies with less consulting revenue from the same issuers).

There are two explanations for these higher ratings: either payments for consulting services are related to lenient treatment by agencies, or the provision of such services is associated with learning. In the second, benevolent interpretation, consulting clients are perceived as safer borrowers by the rating agency that does consulting (but not by its peers), and this effect is stronger for consulting clients that pay higher fees. A direct way to test these competing interpretations is to examine default rates for firms that pay for consulting and those that do not. If the higher ratings of consulting clients are warranted, then – within a given rating category – default rates should be similar for issuers that are consulting clients and issuers that are not. Instead, we find that issuers that pay for consulting services have much higher default rates; this effect increases with the amount of fees paid.

Overall, these results are consistent with a fee-driven conflict of interest between rating agencies and security issuers. When an issuer is directly important to an agency through the fees it generates, then ratings are upward biased. What do the results imply about the role of non-rating services? One interpretation is that because non-rating fee payments are correlated with total fee payments, our results suggest that issuers that generate more financial value for a rater receive upward biased ratings. This interpretation of the results does not necessarily imply any special role for consulting services. However, it is also conceivable that payments for non-rating services are important in their own right, perhaps because rating fees tend to follow fixed schedules and there is more leeway in pricing non-rating services. That would imply that non-rating services are a more direct way of transferring rents to a rating agency, and thus the key variable for predicting biased ratings.

Although our paper provides the most direct evidence on the conflict of interest inherent in the ‘issuer-pays’ model that is predominant in the ratings industry, the findings are consistent with much indirect evidence that the depth of commercial ties between agencies and issuers of structured products affects ratings quality (e.g. He et al. 2012, Efing and Hau 2015).

Our study highlights the potential benefit for the financial system of circumscribing rating agency consulting specifically and fee flows between issuers and raters more generally. Non-rating activities could potentially be prohibited entirely (although this suggestion must be scrutinised for possible negative side effects). As an alternative, increased disclosure may facilitate scrutiny by investors and outsiders of the role non-rating fees play. If data of the type we use were routinely available for the large fixed income markets, there would be scope for outsiders to assess the risk of bias in individual ratings. For corporate issuers, who typically publish annual reports and other public accounting statements, disclosure of the type mandated for their relationships with accountants might prove a template.


Baghai, R and B Becker (2016), “Non-rating revenue and conflicts of interest”, CEPR Discussion Paper 11508. 

Benmelech, E and J Dlugosz (2009b) “The alchemy of CDO credit ratings”, Journal of Monetary Economics 56, 617-634.

EC (2008) Commission staff working document accompanying the Proposal for a Regulation of the European Parliament and of the Council on Credit Rating Agencies, COM 704 final.

Efing, M and H Hau (2015) “Structured debt ratings: Evidence on conflicts of interest”, Journal of Financial Economics 116(1), 46–60.

He, J, J Qian and P E Strahan (2012) “Are all ratings created equal? The impact of issuer size on the pricing of mortgage-backed securities”, Journal of Finance 47(6), 2097-2137.

SEC (2013) “Report to Congress - Credit rating agency independence study”, Securities and Exchange Commission, November.


[1] The role of ratings in India is similar to their role elsewhere (although public placements of corporate bonds are less important than in the US or Europe).

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