Centre for Finance, Credit and Macroeconomics (CFCM)
   
   
  

CFCM 18/02: Preliminary credit ratings and contact disclosure

Abstract

A recent amendment to the European Regulation on credit rating agencies (CRA) requires CRAs to disclose any issuers' request of initial reviews (ie preliminary ratings).  This paper constructs a model of preliminary ratings and uses it to investigate the effect of contact disclosure.  A CRA issues a preliminary rating.  After receiving this confidential rating, the entrepreneur has the opportunity either to purchase an official rating at a cost or to remain unrated.  I identify a trade-off between the fee and the CRA's reputation.  When the project is likely to be good, the CRA issues a good preliminary rating because the risk of losing reputation is extremely low whereas when the project is likely to be bad the CRA prefers to issue a bad preliminary rating avoiding to risk reputation.  I show that when there is disclosure of the contact between the CRA and the entrepreneur, the CRA issues more good preliminary ratings than when there is no evidence of preliminary contact.  Disclosure results in a lower probability of stopping high quality projects but also in a higher probability of financing low quality ones.   

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Author

Marta Allegra Ronchetti 

 


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Posted on Wednesday 31st January 2018

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