Differences of opinion and selection bias in the credit rating industry

Many regulations use private sector credit ratings to determine investment prohibitions and capital requirements for institutional portfolio investments. These regulations implicitly assume that different agencies have equivalent rating scales, despite the fact that some agencies assign systematically higher ratings than others. We assess the appropriateness of these regulatory practices by testing whether observed rating differences reflect different rating scales or simply result from sample selection bias. Our analysis reveals only limited evidence of selection bias. We also ask what types of firms are most likely to seek ratings from the agencies with higher rating scales. Our analysis uncovers no evidence that firms seek ratings from these agencies to clear specific regulatory hurdles or to reduce ex ante uncertainty about default risk. © 1997 Elsevier Science B.V. All rights reserved.