Proposed Reform of the Rating Agency
Compensation Model

Abstract

While there is little disagreement that rating agencies contributed to the financial crisis, the barrage of resulting regulations across the world has yet to address the rating agency compensation model. The authors believe the dominant issuer-pay compensation model, with its inherent conflicts of interests, needs to change, at least for structured financings. Regulators, not only because the industry will resist change, but also because such reform is not easy, have ducked reform of rating agency compensation. The authors propose to replace the dominant issuer-pay model with an issuerand-investor-pay model that squarely addresses the conflicts of interests. This article describes how the new issuerand-investor-pay model might work, including the kind of legislation that such a change would require and how it might be implemented.

TOPICS: Factor-based models, statistical methods