Competition among rating agencies and information disclosure

Abstract

The paper analyzes why a rating agency pools di¤erent credit risks in one credit grade, and how information disclosure depends on the value of information to the market. We build a model to analyze the optimal disclosure policy of a monopoly rating agency depending on the value of information to investors, and then describe the potential market and the strategy of the entrant. We …nd that entry of a symmetric rating agencies results in asymmetric rating scales. It justi…es why some companies obtain multiple ratings and suggests that similar ratings from di¤erent agencies may mean di¤erent credit risks. We empirically test the qualitative predictions of the model. Standard and Poor’s entry to the insurance market that was previously covered by a monopoly agency, A.M. Best, is used as a natural experiment to study the impact of competition on the information content of ratings.

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