Do Credit Rating Announcements Have Informational Value ...

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2.4 Drawbacks with ratings
One major problem since the introduction of the present payment system in the 1970s has of
course been the fact that agencies are paid by the same companies they rate. This increases the
risk of agency conflicts as rating agencies may be tempted to assign higher ratings in exchange for
higher fees. On the other hand maintaining their reputation is of course vital for the rating
agencies since the losses faced in the long run as a result for bad ratings might be considerable
and offset the short-term gains. This reputational factor has considerable value as protection
against the agency conflicts but does not take the risk away.
Another source of risk is the temptation that the rating agencies have to attract more business by
assigning higher ratings. It is only natural that an issuer will minimize its costs and choose to obtain
its rating from the agency that assigns highest rating. Therefore, an agency can make itself look
more appealing to issuers by assigning more favorable ratings in general. This of course does not
work in the long run if investors learn that the ratings of a certain issuer are systematically too
high. The same reputational factor also relates to this problem as described above.
Not all problems in the industry relate to the choices that the agencies can make. There are also
other sources of problems. One problem arises from the actions of the issuers. When a company is
unhappy with a rating it does not have to disclose the rating. It can choose to apply for a rating
from another rating agency and disclose the one that is more favorable. This is called shopping for
ratings. Issuers can easily shop for ratings because normally a rating agency only gets paid if the
rating is issued which minimizes the downside for the issuers. A situation when shopping is
especially harmful is when credit ratings are used as a substitute for adequate disclosure
requirements.
During the recent crisis also the methodological issues and model risk have attracted attention.
However, this is related to rating complex structured products. The ratings of corporations have
remained pretty stable whereas the ratings of structured products have seen massive
downgrading in recent years. The rating of complex products is much different and more difficult
than rating straight debt. Therefore, agencies have received criticism about the use of similar
methodology in both categories. (Bank of England, 2011)