Tianxi Wang (University of Essex)

Simultaneous Reporting of Credit Ratings May Discipline Rating Agencies

Rating inflation has been a major concern in the credit rating industry. We show that requiring a credit rating agency to report many ratings at once may discipline it against rating inflation. When the rating agency has to report ratings simultaneously, it faces a trade-off in the choice of the number of good ratings to report. While reporting one more good rating earns the agency one more fee, it also lowers the credibility of the good ratings the agency gives, thus diminishing borrowers' willingness to pay for a good rating (and consequently the rating fee). In the case of a large number of borrowers, this mechanism ensures an allocation that asymptotically approaches the first best. In the functioning of this mechanism, interestingly, the fact that borrowers pay for the ratings plays a necessary role. This paper suggests an extra benefit to synchronizing the issuance of corporate bonds. ....paper here.