Proceedings of the International Conference on Applied Research in Management, Business and Economics
Year: 2019
DOI:
Compensation Contract Impact on Credit Rating Agencies’ Decision Toward Disclosing Accurate Credit Ratings
Kittiphod Charoontham
ABSTRACT:
This study examines whether an upfront fee or an incentive pay scheme can more effectively discourage issuer-paid rating agencies (CRAs) from issuing inflated ratings. Under the incentive pay scheme, the CRA collects a fixed fee to cover her information production cost and gains rewards if issued ratings correctly reflect outcomes of rated portfolios. In the setting of consideration, an investor invests solely in a high-rated portfolio; the CRA can decide on the disclosure rule and effort exertion level in the information production process. Findings reveal that the incentive pay scheme provides better incentive for the CRA to adopt the full disclosure regime than the upfront fee scheme does. Conditional on the full disclosure regime being adopted by the CRA, the incentive pay scheme can induce the CRA to exert a higher level of effort in the information production process.
Key word: Incentive pay scheme, upfront fee scheme, rating quality, rating inflation regime, full disclosure regime, credit rating agencies.