The Trust Alternative

Abstract

We substantiate the feasibility of a market mechanism that addresses ratings shopping, ratings inflation, and encourages competition over rating accuracy among credit rating agencies (CRAs). An issuer strategically delegates the task to acquire ratings, from CRAs, to a pass-through non-monitoring platform (the "trust"). The trust operates as a commitment mechanism for the issuer and pays outcome-contingent fees, a large portion of which is paid upfront. In turn, high credit rating accuracy assures investors' participation in the market, creating the surplus that guarantees voluntary participation of CRAs and issuers. Overall, the mechanism creates a Pareto-improving equilibrium that requires minimal regulatory intervention.