Issuer-Pays Model

The issuer-pays model is the dominant revenue structure in the credit rating industry: the entity being rated—a corporation issuing bonds, a sovereign seeking a credit assessment, a bank structuring a securitization—pays the rating agency for its analysis. This arrangement creates an inherent conflict of interest: the rater depends on the rated entity for income, yet credibility requires impartial assessment. Since the 2008 financial crisis, the model has been repeatedly criticized, yet persists because alternatives present their own compromises.

Origins: the shift from investor-pays

The credit rating industry began under an investor-pays model. In the nineteenth and early twentieth centuries, rating agencies like Moody’s and Standard & Poor’s compiled credit analyses and sold them to investors—a research product similar to modern equity research or investment newsletters. Investors paid subscription fees or purchased individual reports; the agencies had direct economic relationships with those bearing credit risk.

This model began eroding in the 1960s and 1970s as new technologies disrupted the business. Photography allowed rating reports to be reproduced cheaply, undermining the exclusivity of research subscriptions. Computer systems made credit analysis faster and cheaper to produce. Large institutional investors began hiring in-house credit analysts rather than relying on external ratings. Meanwhile, the volume of debt issuance—especially in corporate bonds and structured products—exploded.

Facing margin pressure, rating agencies experimented with alternative revenue sources. They discovered that issuers (entities seeking ratings) would pay substantial fees for the analytical services and market legitimacy that a rating provided. An issuer could use a rating to access capital markets more cheaply, so it was willing to pay for the analysis—a fee that also guaranteed the agency revenue and recurring relationships as the issuer refinanced or issued new debt.

By the 1970s, the issuer-pays model had become standard. Investor-pays continued at a small scale (some agencies still sell reports to subscribers), but issuer-pays dominates the market. Today, over 95% of ratings are issued on the issuer-pays basis.

How the conflict manifests

The structural conflict is straightforward: an agency rates a company as “A-rated” (strong credit quality) in exchange for a six-figure fee. If the agency later downgrades to “B-rated” (speculative), the issuer feels punished and may shop its business elsewhere—perhaps to a competitor agency seen as more lenient. The agency, facing lost revenue, is subtly incentivized to maintain the higher rating as long as fundamentals remain even marginally defensible.

This is not necessarily conscious corruption. Individual analysts may be talented and well-intentioned. But the business model creates systematic pressure: agencies that consistently downgrade aggressively lose market share to competitors willing to be more generous with ratings. Over time, this selection effect shifts the population of agencies toward laxity.

The bias manifests across products. For corporate bonds, an agency might rate a leveraged company “BBB-” (investment-grade but weak) when the debt-to-equity ratio and cash flow suggest “BB” (junk) would be more accurate. For structured finance—mortgage-backed securities, collateralized debt obligations, and similar products—the incentive to inflate is amplified: securitizations are bespoke and issued in very large volumes, and the issuer (a bank or investment firm) carefully engineers the structure to achieve a desired rating. If one agency refuses to rate the deal, another stands ready to do so.

The 2008 crisis as a watershed

The issuer-pays model’s flaws became catastrophically visible in 2008. Rating agencies had issued triple-A ratings to mortgage-backed securities and collateralized debt obligations packed with subprime loans. Once housing prices declined and defaults accelerated, the triple-A ratings proved worthless—many securities defaulted entirely despite their top-tier ratings.

Investigation later revealed that agencies had:

1. Used optimistic assumptions about housing price appreciation (prices would never decline nationally, or only in isolated regions).
2. Underestimated correlation (the tendency of mortgages to default together during downturns).
3. Failed to stress-test models against severe recessions.
4. Faced intense competitive pressure from issuers: if one agency questioned the structure, the issuer would simply hire a competitor.

The issuer-pays model was not the only cause—flawed models and inadequate data about subprime borrower credit quality played major roles—but the revenue model amplified competitive race-to-the-bottom dynamics.

Congressional and regulatory response included requirements for greater methodological transparency, historical performance disclosure, and some limits on “rating shopping.” The SEC’s Dodd-Frank reforms imposed mandatory registration and higher standards. But fundamentally, the issuer-pays model remained intact.

Why issuer-pays persists

Despite widespread acknowledgment of conflicts, the issuer-pays model has proven remarkably durable. Why?

Investor-pays alternatives face their own problems. If investors paid for ratings, an agency would have incentive to publish ratings for securities that generate trading volume—high-yield bonds, volatile stocks, complex derivatives—while ignoring obscure but important credits like regional municipal bonds or niche corporate issuers. Coverage would concentrate on securities that investors actively trade, leaving many borrowers unrated.

Issuers are the natural clients. An entity issuing debt wants capital markets access and pricing certainty; it is willing to pay for ratings. Investors have no unified willingness to pay because they are diffuse, heterogeneous, and can free-ride on ratings published for other reasons.

Scale and profitability favor issuer-pays. Large issuers—S&P Global Ratings, Moody’s, Fitch—have built vast rating databases, methodologies, and institutional relationships on issuer-pays revenue. Moving to investor-pays would require dismantling that infrastructure. Smaller agencies, lacking scale, struggle to compete and have vested interests in the status quo.

Regulatory lock-in reinforces incumbent revenue models. Once NRSRO status exists and capital regulations incorporate NRSRO ratings, market demand for ratings is effectively captive. Issuers must obtain ratings to access capital markets; they will pay. The regulatory framework insulates incumbent agencies from the market discipline that might otherwise push them toward investor-pays.

Attempted reforms and their limits

Post-2008 reforms included:

• Mandatory registration and oversight: All rating agencies rating US securities must register with the SEC and comply with disclosure and methodological standards.
• Conflict-of-interest rules: Agencies must disclose fees, cannot tie analyst compensation directly to ratings approvals, and must have internal compliance oversight.
• Rating shopping restrictions: Rules attempt to limit competitive rating pressure by requiring disclosure of all ratings (including rejections) and by restricting issuers’ ability to cherry-pick favorable raters.
• Separation of analysts from sales: Some rules require that the analysts issuing ratings be insulated from the sales team seeking to acquire issuer business.

These measures reduce (but do not eliminate) bias. An analyst still works for an agency whose profitability depends on issuer revenue. The compensation may not be directly tied to a rating, but career advancement within an agency depends on landing new issuer clients and expanding market share.

The case for investor-pays: theory and practice

Proponents of investor-pays argue that if investors paid for ratings, agencies would have direct incentives to be accurate. An inaccurate rating that leads to defaults destroys credibility and revenue. This reputational discipline is powerful: investors abandon raters that systematically overstate credit quality.

Yet this logic is incomplete. Investor-pays faces practical hurdles:

1. Free-riding: Investors can access ratings published for one investor (via leaks, republication, or secondary markets) without paying.
2. Fragmentation: Different investor segments may demand different rating methodologies (conservative vs. permissive); a single agency cannot satisfy all.
3. Reduced coverage: Small or illiquid issuers would go unrated because investors don’t demand their ratings.

A few investor-pays or hybrid-pays agencies operate at small scale—primarily in niche markets like structured finance or insurance ratings—but none has achieved the scale of the Big Three issuer-pays agencies.

Alternative models: public agencies and mandatory second opinions

Some reformers propose creating a public (government-backed) rating agency to compete with private agencies and provide baseline credit assessment free or at cost. This could reduce issuer-pays dependency by giving issuers an alternative that doesn’t depend on commercial profitability.

Others propose mandatory use of multiple independent ratings, ensuring that no single agency’s bias dominates. This increases compliance burden but reduces systemic reliance on any single rater.

Both proposals face political and operational obstacles. A public agency would require sustained government funding and would face accusations of political bias (favoring certain sectors or issuers). Multiple-rater requirements increase costs for both agencies and issuers and add complexity to regulatory rule-making.

See also