Open Scholarship Institutional Repository (Washington University in St. Louis) · 1999 · 210 citations · 0 references
Open access
BusinessEconomicsFinanceFinancial EconomicsFinancial MarketsFinancial RegulationBond MarketsCredit DerivativesCredit Rating Agency RegulationCredit RatingsCredit RiskFinancial RiskCredit Rating Agency OversightCredit Rating RegulationCredit Risk SpreadsRating Agency ReputationRatings AccuracyRegulatory Reliance On Credit RatingsReputation In Financial MarketsReputational Capital
Credit rating agencies have long been viewed as accumulating reputational capital by providing valuable bond information, yet credit spreads—differences between bond yields and comparable risk‑free yields—capture all available information and are therefore more accurate and reliable. This paper critiques the traditional role of credit rating agencies and proposes a license view in which they generate value by enabling issuers and investors to meet regulatory requirements. Under the license view, rating agencies facilitate regulatory compliance rather than delivering informational value, thereby creating value through the facilitation of issuers’ and investors’ regulatory obligations. The authors argue that the reputational capital view fails to explain key market behaviors such as credit spread estimation, rating‑driven transactions, and the surge in credit derivatives, and they conclude that regulators should replace regulatory dependence on ratings with a regime based on market‑determined bond credit spreads.
This paper critiques the role of credit ratings and credit rating agencies in providing information about bonds. The dominant view of credit rating agencies is that the agencies have survived and prospered since the early 1900s based on their ability to accumulate and retain reputational capital (i.e., good reputations) by providing valuable information about the bonds they rate. The paper argues that this view fails to explain, and is inconsistent with, certain types of market behavior including: the estimation of credit spreads, the number of credit ratings-driven transactions, and the explosion in use of credit derivatives. In place of the reputational capital view, the paper offers a license view of rating agencies as generating value, not by providing valuable information, but by enabling issuers and investors to satisfy certain regulatory requirements. The paper concludes that regulators should eliminate regulatory dependence on credit ratings by substituting a regime based on market-determined bond credit spreads (i.e., the difference between the yield on a bond and the yield on a risk-free bond of comparable maturity). Such credit spreads reflect all available information, including credit ratings, and therefore are more accurate and reliable than credit ratings.