We compare a credit rating agency's incentives to acquire costly information when it is only paid for giving favorable ratings to the corresponding incentives when the agency is paid up-front, i.e., irrespective of the ratings assigned. We show that, in the presence of moral hazard, contingent fees provide stronger dynamic incentives to acquire information than up-front fees and may induce higher social welfare. When the fee structure is chosen by the agency, contingent fees arise as an equilibrium outcome, in line with the way the market for credit rating actually works.
Bizzotto, Jacopo, and Adrien Vigier.
"Fees, Reputation, and Information Production in the Credit Rating Industry."
American Economic Journal: Microeconomics,
Firm Behavior: Theory
Asymmetric and Private Information; Mechanism Design
Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies