Quality, information and certification

Abstract

This dissertation consists of three chapters that study issues in Corporate Finance and Industrial Organization related to the behavior of markets with asymmetric information. The first two chapters study the economics of credit rating agencies; the third chapter examines a process of social learning about product quality. Chapter 1 models the effect of rating agency competition on the quality of rated securities. I compare equilibria across a regime of competition between two rating agencies and a monopolistic regime. In both regimes, all available agencies are hired in equilibrium, so under competition more ratings are observed. However, competing agencies do not fully internalize the return of a reputation for being honest. Whenever strategic agencies are not very concerned about their reputation, competition can induce more issuer effort than monopoly. Otherwise, a monopolistic agency induces more effort. Chapter 2 analyzes the effect of the Cuomo Plan, a much-discussed regulation that prohibits issuers of residential mortgage-backed securities from making payments to rating agencies contingent on the assigned ratings. I construct a certification model which consists of the following features: (i) an issuer privately informed about her security's quality can hire a rating agency to assign a rating; (ii) the agency can observe, at a cost, a private signal correlated with the quality of the security; (iii) an undeserved favorable rating reduces the agency's future revenues. I show that the Plan has an effect on the informative content of the rating only if the agency's signal is not too costly. In this case, the Plan ensures that the rating is more informative; otherwise the Plan has no effect. In chapter 3, I study the pricing strategy of a monopolistic firm in a market characterized by consumers with heterogeneous preferences and private information about the product quality. Consumers purchase sequentially and observe the history of purchasing decisions, prices, and consumers' preferences. I characterize the conditions under which the monopolist gains when consumers learn the true quality, and, which pricing strategy ensures that learning takes place.