Rating Alignment, Rating Shopping and Reputation of Credit Rating Agencies: Evidence from the Subprime Crisis

Abstract

This paper compares conflict of interest incentives and reputational concerns of credit rating agencies (CRAs) in the context of the subprime crisis. We argue that, during up-market periods, ratings levels are affected by both a strong tendency for alignment across CRAs and ratings "shopping" by issuers, while, during periods of economic slowdown, these distortions disappear since CRAs are then more concerned about their long-run reputation. We test our hypotheses by analyzing the gap between Moody's and S&Ps ratings on US residential, subprime mortgage-backed securities before and after the 2007 crisis. Overall, our results show a clear reduction in ratings alignment. Moreover, we find strong evidence that harsher downgrades came from S&P, which had higher ratings before the crisis, and that the gap reduction is strongly correlated with the rating gap before the crisis. We interpret this as evidence that CRAs try to "reverse the gap", to reduce the impact on their (relative) reputation. Finally, we find that harsher downgrades tend to occur for securities not jointly rated and that the relation between downgrades and initial rating is significantly different across the two agencies, this being consistent with the rating shopping hypothesis. EFM classification codes: 540, 790

Credit rating agencies: Part of the solution or part of the problem?

“…Moreover, Moody's places less weight on per capita income as a positive factor. Reinhart 31 suggests that RAs would do well to incorporate indicators of vulnerability that have received high marks from the literature on the antecedents of currency crises. While RAs, she fi nds, have given much weight to debt-to-export ratios, which have proved to be poor predictors of fi nancial stress, they have given little to indicators of liquidity, currency misalignments and asset price behaviour.…”

“…A fi rst hypothesis is that the economic cycle has an effect on the degree of homogeneity of ratings: CRAs tend to behave similarly during expansionary phases, while they tend to differentiate their opinions during recessionary phases of the cycle. 31 Such a fi nding would counter the argument that the ratings are constructed with cycle-smoothing techniques. 32 A second hypothesis is that CRAs modify the level of severity of their assessments in a countercyclical way in order to accommodate issuers who pay for the ratings: in recessionary phases, opinions are more lenient to meet the need of issuers to fi nd a market for their emissions in more diffi cult macroeconomic conditions.…”

Calificación crediticia, estructura de propiedad de la empresa y consejo de administración: un análisis internacional

“…Así mismo, se puede observar cómo el número total de calificaciones de crédito en ambas agencias -última columna de la tabla 11-, aumenta de los años 2004 a 2008, fiel reflejo de la importancia que tanto para las empresas, como para las instituciones, ha representado el tener un rating que indique el nivel de su riesgo de crédito. A partir de 2008 el número de calificaciones se mantiene constante, en consonancia con el período de crisis financiera, dada la convulsión de los mercados financieros y la aplicación de reglas, como se menciona en algunos artículos (Alp, 2013;Baghai et al, 2014;Croce et al, 2011;Gray et al, 2006;Salvador Muñoz et al, 2011;Wang, 2011), más estrictas por parte de las agencias de rating de crédito. Este último punto, junto con las mayores dificultades financieras a las que las empresas se han de enfrentar, también se ve reflejado en los ratings de las categorías superiores e inferiores.…”