Credit ratings are supposed to be impartial judgments of creditworthiness. They tell investors how likely a company, municipality, or sovereign is to repay its debt. A higher rating means lower borrowing costs; a downgrade raises yields and signals higher risk.
But the credibility of this system has long been undermined by credit rating shopping — the practice of issuers seeking out the most favorable ratings, often by playing agencies against each other. Instead of an unbiased score, what results is a market where ratings can be influenced by who pays, who competes for business, and who is willing to look the other way.
This article unpacks the mechanics of rating shopping, shows how it emerged, highlights famous examples, explains why it persists, and offers lessons for investors and regulators.
How Credit Ratings Are Supposed to Work
- Independent Assessment
Agencies like Moody’s, S&P, and Fitch analyze financial statements, debt structures, and economic conditions. - Signal to Investors
Ratings serve as shorthand for risk, guiding portfolio managers, pension funds, and insurers. - Market Discipline
Issuers with strong fundamentals are rewarded with lower borrowing costs.
In theory, the rating system ensures transparency and fairness. In practice, commercial incentives distort it.
What Is Rating Shopping?
Credit rating shopping is when issuers solicit ratings from multiple agencies and selectively publish or use only the most favorable ones. Agencies know that if they assign a harsh rating, they may lose the mandate to a rival willing to be more generous.
This creates a classic conflict of interest: issuers pay for ratings, but agencies depend on repeat business. The incentive is to please the client rather than investors.
The Mechanics of Rating Shopping
Step 1: Soliciting Proposals
Issuers send financial data to multiple agencies and request indicative ratings.
Step 2: Comparing Offers
If one agency signals a lower rating than desired, the issuer may decline to purchase it.
Step 3: Selective Disclosure
Issuers sometimes only publish the highest ratings in official documents, creating a skewed picture of creditworthiness.
Step 4: Reputational Arbitrage
Large issuers know agencies fear losing marquee clients. This bargaining power pushes ratings upward.
Step 5: Repeat Business
Once an agency is chosen, it has incentive to keep ratings favorable to retain future deals.
Case Studies of Rating Shopping
The Subprime Mortgage Crisis (2008)
Structured finance products like collateralized debt obligations (CDOs) received AAA ratings from multiple agencies. Issuers pressured agencies for favorable treatment, shopping ratings until they secured the best grade. When defaults surged, investors realized the ratings were inflated.
Enron and WorldCom
Before their collapses, both companies maintained investment-grade ratings until shortly before bankruptcy. Agencies, aware of accounting risks, were slow to downgrade for fear of losing clients.
Sovereign Debt Shopping
Some emerging market governments approach agencies informally, seeking the best possible rating. Agencies reluctant to offend potential sovereign clients often give the benefit of the doubt.
Corporate Bond Issuance
Large corporations frequently solicit indicative ratings from all three big agencies. The lowest rating is quietly discarded, while the highest is highlighted in prospectuses.
Why Rating Shopping Persists
- Issuer-Pays Model
Agencies are funded by issuers, not investors. This inherently biases the process. - Oligopoly Power
The “big three” agencies dominate, leaving investors few alternatives. - Market Demand for Ratings
Many institutional investors are required by law or mandate to hold only investment-grade debt. Ratings are gateways to capital markets. - Information Asymmetry
Investors often lack the resources to replicate deep credit analysis, making them reliant on agency judgments. - Weak Disclosure Rules
Issuers are not always required to disclose all solicited ratings. Unfavorable ones can remain hidden.
Consequences of Rating Shopping
For Investors
- Misled about actual risk.
- Forced to hold bonds that appear safe but are riskier.
- Losses when inflated ratings collapse under stress.
For Issuers
- Short-term benefit from lower borrowing costs.
- Long-term danger of losing credibility if defaults occur.
For Markets
- Systemic risk, as seen in 2008 when inflated ratings on mortgage products amplified the global financial crisis.
For Rating Agencies
- Reputational damage when their ratings prove unreliable.
Red Flags of Rating Shopping
Investors should watch for:
- Prospectuses citing only one or two favorable agencies when others exist.
- Sudden changes in ratings just before bond issuance.
- Ratings that diverge significantly from market signals like bond yields or CDS spreads.
- Complex structures (like securitizations) with suspiciously high ratings.
- Agencies heavily dependent on fees from a single large issuer or sector.
Attempts at Reform
Regulatory Changes
- After 2008, the U.S. Dodd-Frank Act sought to reduce reliance on ratings in regulations.
- Europe introduced disclosure rules requiring issuers to list all solicited ratings.
Alternative Models
- Investor-Pays Model: Some advocate for investors funding ratings to reduce conflicts.
- Public Ratings Agencies: Calls for independent or government-backed ratings exist, though independence is questioned.
Greater Transparency
- Agencies are under pressure to publish methodologies and stress-test assumptions.
The Role of Investors
Ultimately, investors cannot outsource judgment entirely to rating agencies. They must:
- Conduct independent credit analysis.
- Compare agency ratings with market signals.
- Demand disclosure of all solicited ratings.
- Be skeptical of sudden rating upgrades before major bond sales.
Could Rating Shopping Cause Another Crisis?
Yes. Corporate leverage is at record highs, and complex products like collateralized loan obligations (CLOs) now play a role similar to pre-2008 CDOs. If ratings are again inflated by shopping, a downturn could trigger mass downgrades and defaults, spreading contagion across global markets.
Conclusion
Credit ratings were meant to be neutral signals of financial strength. Instead, rating shopping has turned them into bargaining chips. Issuers leverage competition among agencies to secure favorable grades, and agencies, reliant on issuer fees, oblige.
The result is a system prone to inflated ratings, distorted markets, and periodic crises. Investors, regulators, and agencies themselves must recognize that a rating is not a fact — it is an opinion shaped by incentives. Unless the conflicts at the heart of rating shopping are addressed, the same cycle of inflated confidence and sudden collapse will repeat.
The lesson is clear: never take a rating at face value. Ask who paid for it, what was omitted, and what incentives shaped its outcome. Only then can investors see beyond the numbers on the page.
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