DIFFERENCES OF OPINION AND SELECTION BIAS IN THE CREDIT RATING INDUSTRY

Many regulations use private sector credit ratings to determine invest ment prohibitions and capital requirements for institutional portfolio investments. These regulations implicitly assume that different agenc ies have equivalent rating scales, despite the fact that some agencies assign systematically higher ratings than others. We assess the appro priateness of these regulatory practices by testing whether observed r ating differences reflect different rating scales or simply result fro m sample selection bias. Our analysis reveals only limited evidence of selection bias. We also ask what types of firms are most likely to se ek ratings from the agencies with higher rating scales. Our analysis u ncovers no evidence that firms seek ratings from these agencies to cle ar specific regulatory hurdles or to reduce ex ante uncertainty about default risk. (C) 1997 Elsevier Science B.V. All rights reserved.