For all t < T ? 1 , the strategy of the RA depends on its own and its competitors' reputation
When A is large, RA1 always gives a GramsR to a bad project. Conversely, when A is small RA1 behaves honestly and gives oasis active profile examples NR to bad projects. In the intermediate range, RA1 has a mixed strategy, with 0 < x1 < 1 . Note that the lower threshold for A is increasing with RA1's reputation.
The results imply that RA1 tends to lie less as its reputation increases (Corollary 3). The intuition behind this result is straightforward. Since we assumed pG = 1 , the reputation of RA1 goes to zero immediately after a project fails. This means that the cost of lying increases with RA1’s reputation while the benefit of lying stays constant. Hence, it is not surprising that RA1 prefers to lie less as its reputation increases. 18 18 Our results in Section 5 show that this is no longer true if pG < 1 . The penalty on reputation will be smaller as the reputation of RA increases, that is, the cost of rating inflation can decrease with reputation, resulting in a “u-shaped” relationship between strategy and reputation.
Furthermore, according to Corollary step 3, RA1’s strategy does boost that have RA2’s reputation. As the explained ahead of, race has a few contrary outcomes with the behavior from RA1: the fresh new disciplining impression and the market-sharing perception. If reputation for its adversary increases, RA1 will get they quicker popular with increase a unique profile provided an inferior requested coming share of the market, and hence commonly function way more laxly. Additionally, RA1 may have incentives to act seriously whenever RA2’s reputation expands in order to maintain its markets leader standing. Our analysis suggests that the market industry-discussing perception tends to control the brand new disciplining impression. You to prospective explanation is the fact that the share of the market of a rating agency is set not simply because of the the character relative to you to definitely of the opponent, plus by natural quantity of their profile. That is, actually a good monopolistic RA do not operate totally laxly, given that or even the character do getting too lowest to help you credibly price really plans. Therefore, the brand new incentives away from a good RA to maintain an excellent character, inside absence of competition, promote brand new disciplining effect of competition weaker. We feel it is reasonable since indeed, provided intellectual investors, a monopolistic RA don’t have unbounded business efforts.
However, the results above are based on a three-period model with the assumption that pG = 1 , that is, the strategic RA is caught immediately after the project fails. The results may be driven by the fact that the RAs only live for three periods, and hence have limited potential gains associated with higher reputation. In order to capture the long-term benefits of reputation under a more general setting, we move on to the next section, where we relax parameter assumptions and compute numerical solutions in an infinite-horizon case.
5 Unlimited-Panorama Options
We currently present the brand new numerical services of your model inside infinite horizon. The fresh numerical option would be once more computed using backward induction, that’s, we basic solve the brand new design regarding the limited months instance, right after which help the quantity of symptoms therefore the harmony means converges on infinite-horizon services.
We assume that the model ends at period T and solve the model backwards. We know that the strategic RA will always lie at period T and T ? 1 , according to Corollary 2. We solve for the equilibrium strategy of the RA described in Section 3. We look at the pay-offs from lying and being honest and determine the strategy. As long as for xt = 1 , RA1 will always choose to lie. Conversely, if for xt = 0 , RA1 will always tell the truth. In all other intermediate cases, there exists a unique xt states that at which RA1 is indifferent between lying or not. Hence, we deduce inductively the equilibrium strategies of RA1. As T goes to infinity, we approach the infinite horizon solution. Since ? < 1 , the Blackwell conditions are satisfied.
