A Framework for Understanding the Acceptability of Rating Agency Methodologies

MGSM Working Paper No. 2005-11

21 Pages Posted: 23 Aug 2005

Date Written: August 2005

Abstract

We examine the practices of various international rating agencies and develop a framework based on the auditor independence model to examine the acceptability of various rating agency methodologies.

Rating agencies methodologies are classified as solicited, unsolicited or co-operative depending upon: (1) whether the rating has been requested; (2) whether the rating agency receives a payment; and (3) what information source the agency uses to form its opinion. These different methodologies will affect the level of independence the agency has in forming an unbiased and objective opinion, and ultimately this will affect the acceptability of the rating.

The unsolicited and co-operative rating methods allow for independence to be maintained because independence is largely driven by agency remuneration. Ultimately, the most acceptable rating methodology is the co-operative rating method because of the greater reliability of the information source that is used in forming the rating opinion.

Keywords: Rating agencies, auditor, independence, co-operative rating

JEL Classification: E10, E62, G20

Suggested Citation

Finch, Nigel, A Framework for Understanding the Acceptability of Rating Agency Methodologies (August 2005). MGSM Working Paper No. 2005-11, Available at SSRN: https://ssrn.com/abstract=785644 or http://dx.doi.org/10.2139/ssrn.785644

Nigel Finch (Contact Author)

Saki Partners ( email )

Australia

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