Can Market Discipline Work in the Case of Rating Agencies?Some Lessons from Moody’s Stock Price.

This paper shows that the stock price of the rating agency Moody’s reacts negatively to ratingactions that are perceived to indicate low rating quality. The reaction is economicallysignificant. The cumulative effect corresponds to a 20% loss in market capitalization. Thissuggests that market discipline can work despite the oligopolistic structure of the ratingindustry. While the study is restricted to the corporate bond sector, it also sheds light on thedebate surrounding structured finance ratings. The finding that market discipline is present inthe mature corporate bond sector supports the view that it could also contribute to thefunctioning of the structured finance sector once the latter has emerged from the subprimecrisis as a mature sector.