Tiebreaker: Certification and Multiple Credit Ratings

Abstract: This paper explores the role played by multiple credit rating agencies (CRAs) in the market for corporate bonds. Moody’s, S&P and Fitch operate in a competitive setting with market demand for both credit information and the certification value of a high rating. We empirically document the outcome of this competitive interaction over the period 2002 to 2007. Virtually all bonds in our sample are rated by both Moody’s and Standard and Poors (S&P), and between 40% and 60% of the bonds are also rated by Fitch. This apparent redundancy in information production has long been a puzzle. We consider three explanations for why issuers apply for a third rating: ‘information production,’ ‘adverse selection’ and ‘certification’ with respect to regulatory and rules-based constraints. Using ratings and credit spread regressions, we find evidence in favor of Certification only. Additional evidence shows that the reported certification effects are consistent with an equilibrium outcome in a market with information-sensitive and insensitive bonds. In such a setting, ratings help to prevent market breakdowns.