Abstract/Summary

Following the inaccurate evaluation of the default risk of certain financial products—such as subprime mortgages and derivatives — that affected the stability of securities markets, the reliability of credit rating agencies (CRAs) has been questioned. CRAs’ activities have exhibited a lack of due diligence and deficiency in their assessment of corporations’ creditworthiness. Moreover, this underscores the failings of the issuer-agency relationship that characterises the ratings business model. This relationship is fraught with major conflicts of interest because the purposes of issuers with regard to their ratings often do not square with investors’ need to receive reliable ratings information. This article argues that CRAs exhibit potential conflicts of interest because they have a financial incentive to accommodate the preferences of bond issuers owing to the fact that the rater is selected and paid by the issuer. This heavy dependence gives rise to ratings inflation and inaccuracy. What is crucial for the raters and, needless to say, the markets is to increase the quality of publicly available information before it is used in a rating assessment.