The Issuer-pays Business Model and Competitive Rating Market: Rating Network Structure

This paper develops an equilibrium model involving credit rating agencies (CRAs), issuers, regulators and investors. The model is based on two key features of the rating industry: the “issuer-pays” business model and competitive market structure. By incorporating the ratings shopping by issuers, we investigate the equilibrium decisions of CRAs and the impact of government regulation on the rating market. More importantly, an evolutionary reform plan named the Rating Network Structure, which is an alliance or a network of CRAs’ rating approaches, is proposed to improve market efficiency. Simulations demonstrate that this structure plays a significant role in increasing rating accuracy and market profits. Furthermore, this paper reveals the detrimental effect of competition on the credit rating industry.