credit rating agencies, Moody’s, Standard & Poor’s, Fitch, Dodd-Frank, financial regulation
Credit rating agencies are important institutions of the global capital markets. If they had functioned properly, the financial crisis of 2008-2009 would not have occurred, and the course of world history would have been different. There is a near universal consensus that reform is needed, but none as to the best approach. The problem has not been solved. This Article offers the simplest fix proposed thus far, and it is contrarian. Unlike other reform proposals, this Article accepts the central role of rating agencies in regulation of investments, and the realities of a duopoly and an issuer-pay model in the industrial organization. While not ideal, this much-maligned state is still well suited for robust competition leading to more accurate credit ratings. The role of regulation should be to create the conditions necessary for competition. This Article proposes that a small, recurring portion of revenue earned by the largest rating agencies should be ceded to fund a pay-for-performance bonus, and they should compete for this incentive-kicker on a periodic winner-take-all basis. This modest, at the margin bonding mechanism would have significant effects on incentives and outcomes: conflict of interest and implicit coordination would be minimized; competition would increase; the quality of ratings would improve. Furthermore, this funding scheme can promote the incubation of smaller and newer competitors through a program of "shadow competition" creating a competitive information market on credit ratings. Since regulation would be required to assess performance, and would not change the fundamental industrial organization, this proposal has the advantage of simplicity and feasibility.
108 Northwestern University Law Review (2013)
108 Northwestern University Law Review (2013).