In their new paper, Rating Agencies and Information Efficiency: Do Multiple Credit Ratings Pay Off?, Stefan Morkoetter, Roman Stebler, and Simone Westerfeld  study whether it benefits investors to have more than one rating agency rate a particular security.

They find that when multiple rating agencies rate a particular tranche of a mortgage-backed security, not only is the initial rating more accurate, but the agencies devote more efforts to ongoing surveillance, increasing the accuracy of the rating over the life of the tranche.  They conclude that the increased efforts are traceable to a healthy competition among agencies; as the authors put it, “Since their activities are directly bench-marked to their peers’, rating agencies are induced to show more effort with regard to their monitoring obligations than observed for single-rated tranches.”

One of the reasons the paper is interesting is because Dodd Frank and the SEC implementing regulations impose new restrictions on conflicts of interest within credit ratings agencies, basically forbidding anyone from the business side from having any involvement with the ratings themselves.  In light of Morkoetter et al’s conclusions, I do have to wonder whether at least some business-side involvement with the ratings process creates a healthy sort of competition.

Morkoetter, Stebler, and Westerfeld also find that of the three major ratings agencies, Moody’s was consistently the most conservative both at issuance and over a tranche’s lifetime (which, they conclude, may be why Moody’s has a very small market share of single-rated tranches).  That would certainly explain why S&P was first sued by DoJ (although Moody’s may be next), but it seems inconsistent with the allegation – offered by DoJ both in its complaint and in the stipulated facts in the S&P settlement – that S&P routinely relaxed its ratings criteria to be more like Moody’s.