Moral hazard, skin in the game regulation and CRA performance

Abstract

This paper investigates the implications of the “issuer skin in the game” regulation for the rating accuracy of a credit rating agency (CRA). The analysis shows that, as well mitigating a moral hazard problem on the issuer's side, skin in the game requirements can also improve the rating accuracy of a CRA involved in the sale. The results also link the accuracy of the CRA's ratings to the severity of the issuer's moral hazard problem. A more nuanced skin in the game rule that accounts for the specifics of the underlying security class can be more desirable rather than the proposed ”one size fits all” rule.