Ricing Policies and Customers' Portfolio Concentration for Rating Agencies: Evidence from Fitch, Moody's and S&P

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INTRODUCTION (1)

Rating agencies are information providers that deliver services aimed at reducing information asymmetry on the financial market (Partnoy, 1999), by expressing judgement summarizing the available public and private information (Cowan, 1991). The information value of the service offered depends, in part, on the agency's degree of independence on the rated entity, given that, based on the agencies' pricing policies, the rating services are charged directly to the rated entity (Kuhner, 2001)2: by virtue of this independence they are acknowledged as External Credit Assessment Institutions (Honohan, 2001).

Investigations into the economic and management balance of the agencies have highlighted limited competition on the market (Partnoy, 2002), developing theoretical models for defining the fee levels to apply for maximizing profit in the period (White, 2002). In the wake of the recent bankruptcy of large companies rated by the agencies, the studies produced on the subject of the independence of rating agencies tend to focus primarily on issues of governance and internal controls (Coskun, 2008), or on the actual exploitation of situations of conflict of interest (Covitz, Harrison 2003), while there are currently no papers investigating exposure to conflicts of interest, as a result of the excessive economic dependence of the agencies from their customers.

The customer lifetime value (hereinafer CLV) is a consolidated model in the field of marketing for discriminating customers on the basis of their economic relevance. The literature highlights the preference for this type of approach, compared to the available alternatives (Kumar, 2008). By applying this model to the customers of rating agencies as well, it is possible to assess the latters' exposure to conflicts of interest (Coffee,1984), based on the favor accorded to issuer-customers, to the detriment of investor-customers (Walter, 2004). The scarce transparency of certain significant information for assessing relations with the single customers, typical of several rating agencies (Committee of European Securities Regulators, 2009), however, requires a degree of simplification/approximation when implementing the analysis model.

This article focuses on the aspects of the agencies' economic independence (section 2.1), the pricing policies adopted by the three top international rating agencies (Fitch, Moody's and S&P) (section 2.2) and the critical aspects related to the application of the CLV model to the agencies' customers (section 2.3). The empirical analysis investigates the customers of the three agencies, considering all the ratings issued in the observed time horizon and taking into account the fees and costs related to the service offered, defines the value of each business relationship in the 1999-2008 time horizon. The description of the sample (section 3.1) is followed by a explanation of the methodology to measure the agency's customer portfolio and to estimate measures useful to identify any potential conflicts of interest (section 3.2), with a discussion of the results for each of the three agencies considered (section 3.3). The last section contains brief conclusions.

Generally speaking, results highlight a low level of exposure to collusion between agencies and each customer, as a function of the revenues generated exclusively by the rating activities, identifying several recurrent features of the agencies' best customers. By differentiating the pricing policy among customers, results change significantly: if higher fees are applied to more relevant customers, the exposure to collusion increase significantly.

LITERATURE REVIEW

The Relevance Of Economic Independence For Rating Agencies

Rating agencies are firms that sell information services about investment risks (Sinclair, 1994), taking on the role of certifiers of the value of the rated assets (Millon, Thakor 1985): the profitability of these enterprises is primarily based on their income, which is a result of the fees paid by the customers requesting the rating services, and the costs incurred in delivering the service (Mattarocci, 2005). …