An examination of the credit rating industry

Starting in the early 2000s, after the accounting scandals involving Enron and WorldCom and continuing throughout the subsequent structured finance debacle of 2008, credit rating agencies have been criticized for the inaccuracy of their ratings. A fundamental question that arises from these episodes is: why were the ratings so misrepresentative? With this question in mind, the aim of this dissertation is to study how reputation, competition, and the incentives provided by bond issuers affect credit ratings accuracy.;The first essay presents and solves a reputational maximization problem which simultaneously models both credit rating industry analyst incentives and the degree of competitiveness within the credit rating industry. The results suggest that if credit rating agencies are reputation maximizers, then reputational concerns alone are unlikely to improve ratings accuracy. The second essay aims to decipher the effects of competition on rating agencies by focusing on whether a credit rating agency was the first, second, or third agency to rate a specific bond issue. The empirical results provide evidence that competition leads to less inflated ratings for only the first rating agency that rates a specific bond issue. The third essay examines the link between the level of the rating provided by the third rater and the rater's stream of future ratings coverage following their issuance of that third rating. The results suggest that ratings shopping is prevalent and that the third rater is rewarded with future business for rating above the first two rating agencies on a particular bond issue.