How did a change in the business model for bond rating agencies contribute to a conflict of interest today?

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In evaluating how a change in the business model for bond rating agencies contributes to a current conflict of interest, we must examine what each option claims and how it aligns with known dynamics in the rating industry.
Option 1: 'Bond rating agencies are paid a fee by the federal government.' This statement is inaccurate in the contemporary context. Historically, government funding is not the standard model for corporate rating agencies in the U.S., and the current core concern is not about government funding shaping ratings.
Option 2: 'Bond rating agencies are now paid by the bond issuers.' This option points to the central conflict of interest: when issuers pay for ratings, agencies may feel pressured to deliver favorable ratings to secure future business from the issuer, undermining perceived objectivity.
Option 3: 'Bond rating agencies now make roughly half their income from those who purchase bonds and half from those who issue bonds.' While this would create a mixed revenue stream, the commonly cited concern is not a precise 50/50 split, and the key issue remains the issuer-paid model that creates incentives to please issuers.
Option 4: 'Bond rating agencies now sell manuals of financial data to the purchasers of bonds.' The practice of selling data or research materials exists in various markets, but this does not address the core conflict linked to who pays for ratings and how that payment relationship might influence ratings themselves.
From this analysis, the most direct route to a stated conflict of interest is the issuer-pays model described in Option 2, as it directly ties the rating agency’s revenue to the party that benefits from favorable ratings, raising concerns about impartiality and risk assessment.
However, to understand why the other options are less plausible, consider that government funding (Option 1) would remove market incentives tied to issuers, which is not reflective of the current system; the precise revenue split in Option 3 is not the widely cited problem even if a mixed model exists; and Option 4 describes a different business activity that does not address the integrity of rating judgments.
Therefore, distinguishing the issuer-paid structure as the root of the conflict of interest helps explain why today’s concerns focus on accountability, credibility, and the potential for ratings to be influenced by issuers’ preferences.

BUSFIN 4265 SP2025 (5285) Quiz #4 Brandl 2e Chapters 14-17

How did a change in the business model for bond rating agencies contribute to a conflict of interest today?

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