Prof. Yuan Xie’s research in Journal of Financial Economics
Areas of Study , Faculty , Finance Stories | Nov 30, 2011 | Nicole Gesualdo
Accounting professor Yuan Xie and two colleagues from other universities will publish important research about bond ratings in the next edition of the prestigious Journal of Financial Economics. Congratulations to Dr. Xie from all of us at the Fordham Schools of Business!
Dr. Xie worked with John (Xuefeng) Jiang, an associate professor of accounting at Michigan State University, and Mary Stanford, an accounting professor at Texas Christian University, to investigate whether charging bond issuers for ratings affects the level of credit ratings issued. They compared the current system, in which bond issuers are charged, with historical systems in which investors were charged instead. (Standard & Poor’s switched from an investor-pay model to an issuer-pay model in 1974, and had Moody’s made the same change four years earlier.)
Critics of the issuer-pay model used now have argued that it creates conflicts of interest that lead to inflations in the credit ratings that are offered.
The three professors studied historical data from the 1970s and concluded that there were indeed differences. They looked at firms that were rated by both Standard & Poor’s and Moody’s during the period from 1971 to 1974, and discovered that Moody’s, on the issuer-pay system, tended to issue higher ratings than S&P, which was still operating under the old investor-pay system. But from 1974 to 1978, when S&P joined Moody’s on the issuer-pay model, there was no longer a discernable difference between the two agencies’ ratings — S&P’s were now higher as well.
Dr. Xie and his colleagues capture the importance of their research in this way: “Because we use Moody’s ratings for the same bond as a benchmark to compare with S&P’s rating and because we compare the two agencies’ ratings both before and after S&P adopts the issuer-pay model, our research design presents a clean test of whether and how much the switch to the issuer-pay fee model influenced credit ratings in the past.”
You can read the research in its entirety here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1950748