Credit Rating Agencies and Moral Hazard

The failure of credit rating agencies to properly assess risks of complex financial securities was instrumental in setting off the global financial crisis. This paper studies the incentives of companies and rating agencies and argues that the way the current rating market is organized may provide agencies with intrinsic disincentives to accurately report credit risk of securities they rate. Informational inefficiency is only enhanced when rating agencies function as an oligopoly or when they rate structured products. We discuss possible market and regulatory solutions to these problems.