Credit Rating Agency Fees: Pay to Play or Pay for Work?

We document a significant relationship between ratings fees and credit rating levels in the municipal bond market. In contrast to prior evidence from the corporate bond and structured finance markets indicating a “pay to play” phenomenon, our results suggest that ratings fees in the municipal market are pay for work. We conclude that rating agency incentives differ across asset classes and that fee disclosure mitigates the conflict of interest inherent in an issuer-pays compensation structure. Our results also suggest a substitution effect between certification agents in the muni market. The strong positive relationship between fees and ratings is exclusive to the subset of now uninsured issuers who previously purchased AAA ratings from MBIA and AMBAC. Without the benefit of the AAA pricing provided by AAA insurers, these issuers have increased incentive to pay rating agencies for certification.