Conflicts of Interest in Subscriber-Paid Credit Ratings

We provide the first evidence of systematic bias among an emerging type of credit rating agency that relies on subscriptions from institutional clients as its primary source of revenue. Using data on Egan-Jones (EJR) ratings, a subscriber-paid rating agency, we show that EJR issues more optimistically biased bond ratings, less timely downgrades, and less accurate ratings for bonds held by more EJR clients. Our evidence is consistent with subscriber-paid agencies optimistically biasing their ratings to bolster subscriber revenue, which allows institutional clients to invest in riskier bonds with higher expected returns. Taken together, our findings suggest that the emergence of subscriber-paid rating agencies as an alternative to more traditional issuer-paid agencies is unlikely to resolve problems arising from conflicts of interest, but rather alter the nature of these conflicts in the ratings process.