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Does It Matter Who Pays for Bond Ratings

In: Business and Management

Submitted By nomelemon
Words 13947
Pages 56
Journal of Financial Economics 105 (2012) 607–621

Contents lists available at SciVerse ScienceDirect

Journal of Financial Economics journal homepage: www.elsevier.com/locate/jfec

Does it matter who pays for bond ratings? Historical evidence$
John (Xuefeng) Jiang a,n, Mary Harris Stanford b, Yuan Xie c a Eli Broad College of Business, Michigan State University, N252 Business Complex, East Lansing, MI 48824, USA M. J. Neeley School of Business, Texas Christian University, Fort Worth, TX 76129, USA c Fordham University, 441E Fordham Road, Bronx, NY 10458, USA b a r t i c l e i n f o
Article history: Received 12 December 2010 Received in revised form 13 July 2011 Accepted 9 August 2011 Available online 7 April 2012 JEL classification: G18 G20 G28 Keywords: Credit ratings Investor pay Issuer pay Moody’s S&P

abstract
We test whether Standard and Poor’s (S&P) assigns higher bond ratings after it switches from investor-pay to issuer-pay fees in 1974. Using Moody’s rating for the same bond as a benchmark, we find that when S&P charges investors and Moody’s charges issuers, S&P’s ratings are lower than Moody’s. Once S&P adopts issuer-pay, its ratings increase and no longer differ from Moody’s. More importantly, S&P only assigns higher ratings for bonds that are subject to greater conflicts of interest, measured by higher expected rating fees or lower credit quality. These findings suggest that the issuer-pay model leads to higher ratings. & 2012 Elsevier B.V. All rights reserved.

1. Introduction This paper investigates whether charging bond issuers for credit ratings leads to higher ratings. The three major credit rating agencies—Standard & Poor’s (S&P), Moody’s Investor Service (Moody’s), and Fitch—have been heavily criticized since 2002, when they failed to foresee the bankruptcies of Enron and WorldCom. During the recent financial crisis, the major…...

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