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Description:
Using legal and economic analysis, this article demonstrates how reputation works in the credit rating business to encourage rating accuracy and how governmental actions were responsible for rendering the reputational mechanism ineffective. Considering the factors which influence the trade-off faced by rating agencies, the movements towards regulation and oversight of these entities in the U.S. and in the EU are comparatively analyzed. The paper concludes that restoring the strength of the reputation mechanism, notably by eliminating regulatory reliance on ratings and rating safe-harbors, is the only effective measure to ensure rating accuracy – as well as the only measure really consistent with the public goals of increasing competition in the informational business, fostering innovation and better risk management by investors, improving accountability in capital markets and ensuring that investors are encouraged to rely on ratings only when ratings are deemed reliable. It then argues that, even though regulation and oversight of rating agencies might have been unavoidable at this point in time, deregulation of the rating business, once regulatory reliance is eliminated, is also indispensable to secure the aforementioned goals.
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