Conflicts of interest in credit ratings of public sector entities

Research team

Ramon Xifré, IQS School of Management, PI
Filippos Maraziotis, IQS School of Management

1. Abstract

Credit Rating Agencies (CRAs) are simultaneously private service providers and quasi-public watchdogs, a dual role that generates persistent conflicts of interest. Although European regulations introduced after the global financial crisis sought to mitigate these problems through stricter disclosure, firewalls, and prohibitions on consultancy, recent controversies show that conflicts have not disappeared but rather evolved. This project will revisit the debate on CRA conflicts of interest with a contemporary focus on European financial markets, combining theoretical analysis, empirical case studies, and governance implications. The ultimate aim is to provide evidence-based insights for policymakers, regulators, and public-sector managers who rely on ratings as tools of external discipline, while proposing pathways to enhance accountability and reduce systemic risk.

2. The Research Focus

The project asks: How do conflicts of interest persist in the credit rating industry despite post-crisis regulatory reforms, and what lessons can be drawn for European financial governance?

Three specific objectives guide the research:

1.To assess how the issuer-pays business model continues to generate moral hazard and perverse incentives.
2.To analyze recent European cases—such as collateralized loan obligations (CLOs), sovereign rating controversies, and ESG verification services—that illustrate the ongoing tensions between commercial imperatives and public oversight.
3.To extract governance lessons that can inform policymakers, supervisors, and public-sector users of ratings.

By weaving together theory, empirical evidence, and regulatory analysis, the project aims to produce a comprehensive understanding of the mechanisms through which conflicts of interest are sustained and to identify realistic policy responses.

3. Background

Credit rating agencies (CRAs) play a central role in modern financial systems as both providers of private information and guardians of public trust. Yet this dual role has long been recognized as a source of tension and controversy. Unlike auditors or securities analysts, CRAs are explicitly embedded in regulatory frameworks: bank capital rules, ECB collateral eligibility, and investment mandates often depend on external ratings (White, 2010). This regulatory reliance effectively grants CRAs a form of delegated authority, amplifying the impact of any conflicts of interest.

The global financial crisis (2007–2009) made these issues highly visible. The mass downgrades of mortgage-backed securities and collateralized debt obligations (CDOs) revealed how conflicts in the issuer-pays model—in which issuers purchase ratings for their own securities—had produced inflated assessments of credit quality (Partnoy, 2006). Scholars demonstrated that agencies discounted reputational risks in favor of short-term revenues, creating a moral hazard problem (Strobl & Xia, 2012).

Post-crisis reforms in Europe attempted to address these vulnerabilities. The European Securities and Markets Authority (ESMA) was granted supervisory powers, agencies were prohibited from offering consultancy services to issuers they rated, and disclosure requirements were strengthened (De Haan & Amtenbrink, 2011). However, subsequent empirical research suggests that reforms were only partially effective. For example, structured finance studies show that CLOs rated by agencies with deeper issuer ties still receive systematically higher ratings than equivalent pools assessed by less-connected agencies (Cornaggia, Cornaggia & Hund, 2017). This pattern echoes earlier evidence on the rating inflation of CDOs prior to the crisis (Bolton, Freixas & Shapiro, 2012).

The persistence of conflict extends beyond structured products. In sovereign ratings, Italy’s 2011 experience demonstrated that conflicts can arise even when methodologies, rather than specific securities, are at stake. A CRA simultaneously placed Italy under negative watch while marketing paid methodology briefings to the Ministry of Economy and Finance, triggering political scrutiny and regulatory tightening (Gaillard, 2014). Similarly, Spanish regional borrowers confronted with unsolicited negative ratings by large agencies often sought ratings from smaller competitors, who delivered systematically higher grades—a phenomenon consistent with “rating shopping” predicted in theoretical models (Becker & Milbourn, 2011).

Finally, the expansion of CRAs into ESG (Environmental, Social, and Governance) services has revived concerns about blurred boundaries. When the same agency both evaluates credit risk and sells ESG verification, ancillary revenue streams may dilute analytical independence (Boot, Milbourn & Schmeits, 2006). Scholars warn that this cross-subsidization can create new channels of conflicts, potentially repeating the mistakes of pre-crisis consultancy services under a different label (Opp, Opp & Harris, 2013).

Together, these cases illustrate that post-crisis reforms have mitigated some conflicts but failed to eliminate the structural misalignments inherent in the CRA business model.

4. Project Thesis

This project advances the thesis that post-crisis regulation has reshaped but not resolved conflicts of interest in the credit rating industry. Instead, reforms have displaced conflicts into new domains—structured finance, sovereign rating interactions, and ESG-related services—without addressing the core misalignment embedded in the issuer-pays model.

At the theoretical level, three strands of scholarship converge on why this persistence occurs:

Moral hazard and timing of costs: Issuer-paid agencies face an asymmetry between immediate revenues and delayed reputational sanctions. Since reputational damage occurs only after defaults materialize—often years later—the short-term incentive to inflate ratings dominates (Strobl & Xia, 2012).

Competition and rating shopping: Contrary to classical economic logic, competition in the CRA market can reduce rather than increase quality. When multiple agencies vie for mandates, issuers may shop for the most favorable rating, leading agencies to strategically relax standards to win business (Becker & Milbourn, 2011; Bolton, Freixas & Shapiro, 2012).

Regulatory rents and embedded reliance: Because ratings are deeply embedded in financial regulation—shaping bank capital requirements, investment mandates, and ECB collateral frameworks—CRAs capture regulatory rents that intensify conflicts of interest (White, 2010; Opp, Opp & Harris, 2013). Agencies effectively profit from their quasi-official status, reducing incentives to align behavior with public objectives.

Empirical evidence supports this thesis. Structured products continue to exhibit inflated ratings in contexts of strong issuer-agency ties (Cornaggia et al., 2017). Sovereign and sub-sovereign ratings display inconsistencies linked to commercial incentives and strategic shopping (Gaillard, 2014). ESG services present a novel arena for conflicts, where blurred boundaries between credit analysis and ancillary activities echo pre-crisis patterns of consultancy (Boot et al., 2006).

The thesis therefore argues that the persistence of conflicts is not accidental but systemic. Unless the market design or supervisory mechanisms realign incentives—either through structural reforms to the business model or deeper regulatory interventions—inflationary pressures in credit ratings will continue to pose risks to European financial governance.

5. Methodology

The project adopts an interdisciplinary and multi-method approach:

(a) Theoretical framework

•Draws on economic models of moral hazard, multi-principal competition, and regulatory capture.

•Uses comparative institutional analysis to situate CRAs within European financial governance.

(b) Empirical analysis

•Case studies: CLO rating practices, Italy’s 2011 sovereign rating controversy, Spanish regional borrowing, and ESG verification services.

•Data sources: CRA rating reports, ESMA supervision documents, parliamentary hearings, and financial press coverage.

•Quantitative evidence: Secondary datasets (e.g., Bloomberg, Refinitiv) to examine rating differentials and issuer-agency relationships.

(c) Policy analysis

•Review of European and international regulatory frameworks (ESMA, ECB, IOSCO).

•Interviews with regulators, market participants, and public-sector managers to gather practical insights.

•This triangulation of methods ensures analytical depth, empirical grounding, and policy relevance.

6. Outcome and Dissemination

Expected outcomes:

•Academic publications in journals of financial regulation and political economy.

•Policy briefs targeted at European regulators, ministries of finance, and public debt managers.

•Workshops brin

•ging together academics, policymakers, and market participants to discuss findings.

Dissemination strategy:

•Presentations at major conferences (European Economic Association, Public Management Conferemce).

•Open-access working papers to maximize reach.

•Collaboration with European think tanks (e.g., Bruegel, CEPS) for policy dialogue.

By combining scholarly outputs with policy-oriented dissemination, the project ensures both academic contribution and practical impact.

7. References

Becker, B., & Milbourn, T. (2011). How did increased competition affect credit ratings? Journal of Financial Economics, 101(3), 493–514. https://doi.org/10.1016/j.jfineco.2011.03.012

Bolton, P., Freixas, X., & Shapiro, J. (2012). The credit ratings game. Journal of Finance, 67(1), 85–111. https://doi.org/10.1111/j.1540-6261.2011.01708.x

Boot, A., Milbourn, T., & Schmeits, A. (2006). Credit ratings as coordination mechanisms. Review of Financial Studies, 19(1), 81–118. https://doi.org/10.1093/rfs/hhj001

Cornaggia, J., Cornaggia, K. J., & Hund, J. (2017). Credit ratings across asset classes: A long-term perspective. Review of Financial Studies, 30(12), 4167–4214. https://doi.org/10.1093/rfs/hhx065

De Haan, J., & Amtenbrink, F. (2011). Credit rating agencies. De Economist, 159(4), 365–390. https://doi.org/10.1007/s10645-011-9172-5

Partnoy, F. (2006). How and why credit rating agencies are not like other gatekeepers. Brooklyn Law Review, 84, 43–92. https://doi.org/10.2139/ssrn.900257

Opp, C., Opp, M., & Harris, M. (2013). Rating agencies in the face of regulation. Journal of Financial Economics, 108(1), 46–61. https://doi.org/10.1016/j.jfineco.2012.10.011

White, L. J. (2010). Markets: The credit rating agencies. Journal of Economic Perspectives, 24(2), 211–226. https://doi.org/10.1257/jep.24.2.211

Gaillard, N. (2014). A century of sovereign ratings. SpringerBriefs in Economics. https://doi.org/10.1007/978-3-319-05146-9

Strobl, G., & Xia, H. (2012). The issuer-pays rating model and ratings inflation: Evidence from corporate credit ratings. Review of Financial Studies, 25(7), 2295–2329. https://doi.org/10.1093/rfs/hhs056

 
ANNEX – In Catalan

Relació de la proposta amb el document d’IQS “PRIORITZACIÓ D’AJUTS PDI DE LA URL”

1. Impuls al PDI jove o de recent incorporació:
Es prioritzaran les sol·licituds de personal docent i investigador que s’hagi incorporat a IQS en els darrers anys, amb especial atenció a qui encara no hagi tingut accés a cap ajut competitiu. Seria desitjable una antiguitat mínima d’un any com a PDI a la institució en el moment de la convocatòria.

El PI es va incorporar a IQS el curs passat i l’altre membre de l’equip de recerca s’ha incorporat a principis d’aquest curs. El PI no ha tingut accés a cap ajut competitiu.

2. Equitat en l’assignació històrica d’ajuts:
Es donarà preferència a sol·licitants que no hagin estat beneficiaris d’ajuts similars en convocatòries anteriors (darrers 3 anys), amb l’objectiu d’evitar repeticions sistemàtiques i assegurar una distribució més equilibrada dels recursos dins de la comunitat investigadora.

El PI no ha estat beneficiari d’ajuts URL.

3. Diversificació entre grups de recerca:
Es valoraran positivament les propostes que no provinguin dels grups habitualment finançats, per tal d’afavorir una distribució més àmplia del suport institucional i estimular noves línies i iniciatives de recerca emergents.

Sense observacions.

4. Compromís actiu amb la captació de recursos:
Es prioritzaran aquells perfils que, malgrat tenir menys recursos disponibles,
demostrin un esforç actiu i sostingut per presentar sol·licituds a convocatòries
competitives (regionals, estatals o internacionals), encara que no sempre hagin estat concedides.

El PI ha estat actiu en la captació de recursos i en el curs passat va presenter dues propostes de projectes:
-La Caixa Social Research Call, superada la primera fase i desqualificada a la segona fase, 115.000 euros
-Independent Social Research Foundation, concedit, 8000 euros

5. Evitar dependència única d’aquest ajut:
No es considerarà prioritari aquell PDI que només hagi sol·licitat aquest ajut i no hagi participat en cap altra iniciativa de recerca, amb l’objectiu d’incentivar una actitud proactiva en l’activitat investigadora i una planificació estratègica més àmplia.

Veure punt anterior. Aquest projecte contribueix a la planificació estratègica perquè estimula la col·laboració entre investigadors de la School of Management.

6. Intensificació de recerca, reduint hores de classe (buyout):
La reducció de l’activitat docent podrà prioritzar-se quan se superin les 8 hores de
classe setmanals en els dos semestres del curs. L’import del buyout definit per P&O per al curs 2025-26 és de 6.743 €.

El PI necessita alliberar temps de docència per a poder mantenir la productivitat en recerca i poder complir amb els compromisos adquirits en recerca, ateses les altres obligacions de gestió que té encarregades per IQS.

Publicacions del PI en els darrers dos anys:

Campos C, Dias A, Gallego M, Gutiérrez D, Quinteiro P, Villanueva-Rey P, Oliveira S, Albertí J, Bala A, Fullana-i-Palmer P, Fullana-Puig M, Melón M, Sazdovski I, Rodríguez E, Roca M, Xifré X, Laso J, Margallo M, Aldaco R (2025). Tool for Greener Tourism: Evaluating Environmental Impacts. Sustainability 17 (8).

Kasperskaya, Y., Xifré, R. (2024). New development: Income and gender equality, Spanish spending reviews and public values. Public Money & Management, 44(8), 719-722.

Arfelis, S, Malpartida, I, Bala, A, Lair, V, Xifré, R, Aguado, R, Delgado-Aguilar, M, Pardhuhn, J, Sazdovski, I, Fullana-i-Palmer, P (2024). Wood Chips Components Separation with a New Wet-Milling Process Compared to Chemical Depolymerization: A Technical, Economic, and Environmental Comparison. ACS Sustainable Chemistry & Engineering, 12, 5105-5116.

Campos, C, Dias, AC , Quinteiro, P, D Guitérrez, Villanueva-Rey, P, Gallego, M, Oliveira, S, Laso, J, Albertí, J, Bala, A, Fullana-i-Palmer, P, Mélon, L, Fullana, M, Sazdovski, I, Roca, M, Xifré, R, Margallo, M, Aldaco, R (2024). Assessing the environmental impacts of three different types of accommodations in Portugal and Spain by using an LCA approach. Science of The Total Environment. Vol. 927, 172230.

Campos, C., Gutiérrez, D., Dias, A. C., Quinteiro, P., Herrero, Á., Gallego, M., Villanueva-Rey, P., Laso, J., Albertí, J., Fullana-i-Palmer, P., Bala, A., Mélon, L., Fullana, M., Sazdovski, I., Roca, M., Xifré, R., Margallo, M., & Aldaco, R. (2024). ‘Small-scale’ tourism versus traditional tourism: Which will be the new key to achieve the desired sustainable tourism? Science of the Total Environment, Vol. 912, 168964.