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Reputation as an Entry Barrier in the Credit Rating Industry

By Doh-Shin Jeon and Stefano Lovo

Abstract

We study competition between an incumbent Credit Rating Agency (CRA) and a sequence of entrant CRAs that are potentially more e¤ective but whose ability in appraising default risk is unproven when they enter the market. We show that free entry competition fails to select the most competent CRA as long as two conditions are met. First, investors and issuers trust the incumbent CRA to provide a sincere, although imperfect, assessment. Second, CRAs cannot charge higher fees for low rating than for high rating. Then, a rather incompetent CRA can dominate the market without concerns about entry. We derive policy implications.Credit Rating, Entry Barrier, Reputation, Credit Constraint, Private Information

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