Corporate Governance is the Problem, not the Solution: A Critical Appraisal of the European Regulation on Credit Rating Agencies

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This paper argues that corporate governance, and executive and employee compensation in particular, was a key driver behind the decline in the quality of the ratings issued by credit rating agencies (CRAs), which in turn contributed to the financial crisis. It argues that the most common explanations for the failure of CRAs, including conflict of interest, inadequate models and insufficient staff were themselves driven by the incentives provided to decision-makers. In support of its argument, it draws on a number of recent inquiries and reports on the causes of the crisis. It then critically analyses the European Regulation on CRAs, paying particular attention to its reliance on corporate governance structures to deal with conflicts of interest. It emphasises that US-based CRAs already had equivalent structures in place before the crisis, but that they did not prevent the decline in ratings quality. Indeed, they put in place the remuneration schemes which this paper argues drove the decline in quality. It concludes with some suggestions as to other ways in which CRA failure might be prevented in future and how the Regulation might be improved.