The Design and Business Models of Financial Ratings

Who pays for financial information determines its design: investor-paid ratings maximize informativeness about firm fundamentals to increase trading profits; firm-paid ratings bundle signals about fundamentals and corporate insiders' effort, strengthening incentives via their effect on market prices. 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. However, in liquid markets, the equilibrium rating is investor-paid. With competition, 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.