Government-run Credit Rating Agency and Social Welfare

This paper considers the social welfare implications of having a public rating agency in-stead of private sector credit rating agencies. The public rating agency is assumed to pay a fix compensation rather than a performance sensitive compensation and is assumed to dismiss its employee in case of "misconduct." The model predicts that the public rating agency may be socially beneficial if investors assign a large enough value to high ratings so that the private rating agency would have an incentive to engage in regulatory arbitrage. However, the model also reveals that the public rating agency’s performance in terms of social welfare is sensitive to its penalty provisions and thus may create inefficiency under changing regulatory and technological environments.