Market Information And Rating Agency Catering
Speaker(s) Prof. Radhakrishnan Gopalan Publication RBI, Main Bldg, 1st Floor, New Conference Room

We examine how the potential for public market scrutiny and the availability of market information affects the credit ratings process. Market information can serve as a disciplining device that limits conflicts of interest arising from the issuer-pay model. Consistent with this view, for a sample of unlisted and listed Indian firms, we find that unlisted firms have higher (i.e., more favorable) ratings than listed firms. The ratings of the former are also less dispersed and are less sensitive to financial condition as reflected in audited financial statements. Consistent with lax rating agency monitoring of unlisted firms, downgrades of listed firms in an industry predict subsequent downgrades of unlisted firms. We do not find a similar pattern for upgrades. Ratings and rating transitions of listed firms are also incrementally more informative about subsequent defaults. Collectively, these findings suggest that lack of market information increases conflicts of interest from the issuer-pay compensation model. The Basel Accords allow banks to condition capital allocation on borrowers' credit ratings. Our study cautions against this practice for unlisted firms.

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