Project Details
Projekt
Biased towards home, drained towards banks. Do biases in analyst views and analyst composition affect credit rating quality?
Subject Area
Economic Policy, Applied Economics
Term
from 2016 to 2018
Project identifier
Deutsche Forschungsgemeinschaft (DFG) - Project number 285168384
Over the last 15 years, the leading credit rating agencies such as Moody's, Standard and Poor's and Fitch have met several waves of criticism. The Asian crisis, the accounting scandals of the early 2000s, the subprime crisis and the Euro debt crisis have sparked both public debates and academic research. The dominant theme of the discussion is that rating quality can be impaired by market structure and conflicts of interest. Accordingly, most reform proposals focus on a reduction of entry barriers, a change of incentive structures, and an increase in transparency. In this empirical research project, we want to shed light on possible sources of low rating quality that have received little attention so far: biases at agency level that pertain to subsets of issuers, and biases on the analyst level. For the former type of bias we want to focus on cultural and political drivers of rating behavior, because the dominant agencies have often been accused of wrongly imposing their Anglo-Saxon perspective on international issuers. For the latter type, we will first test whether biases in the views of individual analysts translate into biased ratings. This analysis will include much more information than the one on the agency level, e.g. the cultural or educational background of individual analysts. We will also examine whether analyst transitions to other employers lead to a brain drain that biases the pool of analysts towards a low quality. Results derived from our project will give important insights regarding the objectivity of rating agencies. Both regulators and agencies could use our findings to address any inconsistency observed in the rating process of corporates and sovereigns. In addition, bond market investors would learn whether, and if yes how severely, credit ratings have been biased. Our results with respect to analyst-specific effects will be relevant for the internal organization of rating agencies and their regulation. For example, they will help to evaluate whether agencies should strengthen the role of the rating committee vis-à-vis the lead analyst, and whether they should establish culturally diverse rating committees. The outcome of our brain drain analysis, finally, will provide additional evidence on the role of individual analysts. If there is a brain drain, agencies could consider changes in processes in order to mitigate its consequences (e.g. strengthen the rating committee or give more weight to quantitative models). On the regulatory side, brain drain effects can matter for the evaluation of reforms that, through a change in market structure, lead to a reduction in agencies' profits, as this can make it more difficult to provide analysts with attractive packages.
DFG Programme
Research Grants
