04-09 Competition among rating agencies and information disclosure ∗

Abstract

The paper proposes an explanation for why a rating agency chooses to pool different credit risks in one rating class, and analyzes how information disclosure depends on the value of information to the market. We show that an optimal disclosure policy of a monopoly rating agency is to pool companies or issuers in multiple rating classes and to have partial market coverage. It provides an opportunity for market entry. We then describe the potential market and the strategy of the entrant. We find that entry of an identical rating agency results in asymmetric rating scales. It justifies why some companies obtain multiple ratings and suggests that similar ratings from different agencies may mean different credit risks. We use Standard and Poor’s entry in to the market for insurance ratings- a market that was previously covered by the monopolist agency the A.M. Best Company- to empirically test the qualitative predictions of the model regarding the impact of competition on the information content of ratings