Large rating agencies (RAs), Such as Standard & Poor's, have come under increasing criticism in recent years for a multitude of reasons.Here are just a few.

First, the RAs are too cozy with the companies they rate.The close relationships with management, which include frequent meetings along with advice on actions companies should take to maintain current credit ratings, foster a familial atmosphere that interferes with independent, unbiased rating judgments.Furthermore, because the RAs are paid by the companies they rate, rather than the investors they are meant to protect, a clear conflict of interest exists.

Second, because the rating business is reputation-based (why pay attention to a rating that is not recognized by others?), barriers to market entry are high and the RAs are oligopolists.(An oligopoly is a market that is dominated by just a few sellers.)This means that the RAs are somewhat immune from forces that apply to competitive markets and, to an extent, can set their own rules.Finally, in many instances, the debt market (through lower bond prices) have indicated a company's deteriorating credit quality many months before a rating downgrade occurred.This fact has led many observers to suggest that, rather than rely on ratings, investors and regulators should use credit spreads to make judgments about credit risk.(Credit spreads reflect the difference in yields in interest rates on "safe"debt, such as Treasury securities, and on risky debt, such as B-rated bonds.)

What do you think about the validity of credit ratings?Do criticisms of RAs have merit?Can the current credit rating system be improved?If so, how?

Answer rating: 100% (QA)

The criticisms of large rating agencies RAs like Standard Poors raise valid concerns about the potential conflicts of interest lack of independence an... View the full answer