Viability of a Government Run Credit Rating Agency

This paper considers a hypothetical government-run credit rating agency with a “fixed compensation” scheme. Taking as granted the fact that investors ascribe higher value for highly rated assets, the model attempts to see whether government intervention can lead to a more socially desirable solution. The model features a free rating agent who can either choose to work for the government agency or the private sector. We find that if the regulatory advantage of highly rated assets is high enough so that the rating agent has an incentive to cater to the investors and overrate the assets, the government may improve social welfare by offering a very high fixed compensation. However, it shows that intervention is undesirable when the regulatory advantage is not large enough. The result implies that different economic environments, such as the regulatory regime, macroeconomic conditions, etc., warrant different solutions.