This paper examines how the information quality of ratings from an issuer-paid rating agency (Standard and Poor's) responds to the entry of an investor-paid rating agency, the Egan-Jones Rating Company (EJR). By comparing S&P's ratings quality before and after EJR initiates coverage of each firm, I find a significant improvement in S&P's ratings quality following EJR's coverage initiation. S&P's ratings become more responsive to credit risk and its rating changes incorporate higher information content. These results differ from the existing literature documenting a deterioration in the incumbents' ratings quality following the entry of a third issuer-paid agency. I further show that the issuer-paid agency seems to improve the ratings quality because EJR's coverage has elevated its reputational concerns.

This paper develops a dynamic rational expectations model of the credit rating process, incorporating three critical elements of this industry: (1) the rating agencies' ability to misreport the issuer's credit quality, (2) their ability to issue unsolicited ratings, and (3) their reputational concerns. We analyze the incentives of credit rating agencies to issue unsolicited credit ratings and the effects of this practice on the agencies' rating strategies. We find that issuance of unfavorable unsolicited credit ratings enables rating agencies to extract higher fees from issuers by credibly threatening to punish those that refuse to acquire a rating. Also, issuing unfavorable unsolicited ratings increases the rating agencies' reputation by demonstrating to investors that they resist the temptation to issue inflated ratings. In equilibrium, unsolicited credit ratings are lower than solicited ratings, because all favorable ratings are solicited; however, they do not have a downward bias. We show that, under certain conditions, a credit rating system that incorporates unsolicited ratings leads to more stringent rating standards.

Many financially distressed students who qualify for federal assistance plans with interest moratorium and principal forgiveness instead accrue interest over long periods of nonpayment. This loan mismanagement is associated with higher delinquency. Mismanagement varies significantly across student gender and race: it is more prominent among male and non-white students. Mismanagement also varies across loan servicers, depending on proxies for student-adverse servicer policies. We consider explanations based on student selection and servicer treatment for loan mismanagement. Student financial literacy plays an important role but variation in treatment on the part of loan servicers appears more important. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online

We examine how securitization markets affect the role of banks as monitors in corporate lending. We find that banks active in securitization impose looser covenants on borrowers at origination. After origination, these borrowers take on substantially more risk than do borrowers of non-securitization-active banks. We use borrowers' geographic locations to instrument for borrower-lender matching to distinguish the effect of securitization on the banks' ex post monitoring from its effect on ex ante screening. We further investigate direct evidence of banks' monitoring role by examining their actions following covenant violations and find that securitization-active lenders are more likely to grant waivers without changing loan terms. Our results suggest that banks exert less effort on ex post monitoring when they can securitize loans.

Using institutional equity trading data, we find that a set of small institutional investors consistently follow credit ratings issued by an investor-paid rating agency in their trading decisions. Although rating information is credit related, we find that these followers often respond more strongly to investor-paid ratings than to influential trading signals, such as earnings announcements, analysts' earnings forecast revisions, and recommendation changes. Followers outperform non-followers, and show improved trading performance after becoming followers. We conclude that investor-paid rating agencies offer small institutional investors a cost-effective alternative to in-house research.

This paper develops a dynamic rational expectations model of the credit rating process, incorporating three critical elements of this industry: (1) the rating agencies' ability to misreport the issuer's credit quality, (2) their ability to issue unsolicited ratings, and (3) their reputational concerns. We analyze the incentives of credit rating agencies to issue unsolicited credit ratings and the effects of this practice on the agencies' rating strategies. We find that issuance of unfavorable unsolicited credit ratings enables rating agencies to extract higher fees from issuers by credibly threatening to punish those that refuse to acquire a rating. Also, issuing unfavorable unsolicited ratings increases the rating agencies' reputation by demonstrating to investors that they resist the temptation to issue inflated ratings. In equilibrium, unsolicited credit ratings are lower than solicited ratings, because all favorable ratings are solicited; however, they do not have a downward bias. We show that, under certain conditions, a credit rating system that incorporates unsolicited ratings leads to more stringent rating standards.

We show that installing stronger risk management into financial institutions—a proposal widely discussed following the 2008 financial crisis—is insufficient to constrain institutions’ exposure to investment with lurking risk, such as asset-backed securities (ABS). Regulations affect the functioning of risk management: risk management constrains institutions’ exposure to risky ABS when they face mark-to-market reporting combined with capital requirements; however, this role is considerably weaker when capital requirements are combined with historical cost accounting. We find suggestive evidence that financial regulations affect risk management functions through promoting risk managers’ efforts in uncovering ABS risk and curbing executives’ incentives to take excessive risk. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Using a difference-in-differences (DiD) setting that leverages the staggered adoption of R&D tax credits across the U.S. states, we show that after a firm receives the tax credits, products of its peers become significantly more similar to the recipient firm. Such product convergence is particularly strong when peer firms face greater pressure from market participants to uphold short-term performances. We further show that the effect of R&D tax credits likely works through the increased technology spillovers, which motivate peers to imitate instead of differentiating. Accordingly, we show that peer firms shift their patent composition from breakthrough to incremental innovations following the R&D tax subsidy.

Credit analysts often leave rating agencies to work at firms they rate. We use benchmark rating agencies as counterfactuals to measure rating inflation in a difference-in-differences framework and find that transitioning analysts award inflated ratings to their future employers before switching jobs. We find no evidence that analysts inflate ratings of other firms they rate. Market based measures of hiring firms' credit quality further indicate that transitioning analysts' inflated ratings become less informative. We conclude that conflicts of interest at the analyst level distort credit ratings. More broadly, our results shed light on the economic consequences of revolving doors.

Unlike labor income, human capital is inseparable from individuals and does not completely accrue to creditors. Therefore, human capital investment is more resilient to “debt overhang” than labor supply. We develop a dynamic model displaying this difference. We find that while both labor supply and human capital investment are hump-shaped in household indebtedness, human capital investment declines less aggressively as indebtedness builds up. Importantly, because human capital is only valuable when households expect to supply labor, the greater reduction in labor supply due to debt overhang back-propagates into ex-ante human capital investment. We provide empirical support for the model.