The Credit Rating Game: Evidence from a Strategic Game Model

This paper empirically analyzes the effect of competition on rating quality under the "issuerpay" compensation scheme. Using hand-collected data of collateralized debt obligations (CDOs), we specify the competition among credit rating agencies with a discrete game framework and test its influence on the rating quality. We find that competition raised the probability of choosing lenient rating by 31% for Moody’s and 27% for S&P in the sample period of 2007-2008. We further demonstrate that the propensity for selecting lenient rating increases with the bargaining power of the underwriters and the complexity of the CDOs. Overall, we find evidence suggests that competition among CRAs reduces their rating quality under the "issuer-pay"