The Design and Business Models of Financial Ratings

We study the corporate governance implications of information intermediaries. By affecting firms' market valuations, intermediaries can strengthen corporate insiders' implicit incentives, but whether they do depends on who pays for their ratings. Investor-paid ratings maximize informativeness about firm fundamentals; firm-paid ratings bundle signals about fundamentals and corporate insiders' effort. When fundamental uncertainty is sufficiently high, firm-paid ratings achieve time horizon irrelevance: insiders exert the same effort as under commitment regardless of their exit horizon, which neutralizes short-termism. In liquid markets, investor-paid ratings dominate: bad information drives out good. Competition can worsen this distortion: the mere threat of entry distorts rating design and reduces effort. The framework sheds light on the funding of credit ratings, the narrow focus of venture capital, and the coexistence of investor-paid and firm-paid ESG information.