Whose Side You Are On When Both Sides Paid You

Abstract

Consider a simple question: who pays you, who do you serve, and what happens when the payer wants the served party harmed? This is not a thought experiment; it's a description of the structural conflict that every multi-sided business faces. Take, for instance, a credit rating agency. The agency is paid by the issuer of the security being rated, but its ratings are meant to serve investors. If the issuer wants a high rating to attract investors, but the agency knows the security is risky, what does it do? Before 2008, credit rating agencies operated under an issuer-pays model. Analysts inside these agencies knew that their ratings had to be honest, but the structure could not reliably produce honest ratings. The agencies were paid by the issuers, and there was a clear incentive to provide favorable ratings. The result was a catastrophic failure of trust. The 2008 financial crisis revealed that many securities had been given high ratings when they were actually very risky.