5.step one Monopolistic RA
Earliest, i consider the situation where there is certainly singular RA from inside the industry. To produce RA1 a beneficial monopolist, i place the new history of RA2 so you’re able to 0.
Figure 3 plots the strategy of the monopolistic RA for parameters ( ? , pGrams , ? ) = (0.5, 0.7, 0.9). 19 19 Note that, we have chosen this set of parameters ( ? , pG , ? ) = (0.5, 0.7, 0.9) for the purpose of illustration only, and verified that our results are robust to other parameter specifications, the plot of which are available upon request. In particular, robustness checks of the main results (Section 5.3) are presented in Appendix B. We can clearly see the strategy of RA1 is “u-shaped” in its reputation. Intuitively, the RA’s strategy is determined by the trade-off between current fees and expected future income. When its reputation is very low, the RA’s expected future income is very small compared to current fees, hence it has little incentive to behave honestly. When its reputation increases, the RA’s future income becomes tastebuds larger while current fees stay the same, the RA tends to lie less. However, when the RA’s reputation is very high, the penalty for lying decreases, and the RA starts to lie more. The reason that the penalty for lying decreases with reputation is that investors attribute project failures to bad luck rather than lax behaviour when they believe that the RA is very likely to be of the honest type.
Moreover, we can see from Figure 4 that the strategy of RA1 is increasing in ? but decreasing in pG . 20 20 We have also verified that this result holds in the case of competitive RAs, the plots of which are available upon request. The intuition is that, the reputational penalty of lying depends on how the investors update their beliefs. If projects are more likely to be good (higher ? ) or if good projects are more likely to fail (lower pG ), then a failure is more likely to be attributed to bad luck rather than lying. Anticipating this smaller cost of lying on reputation, the RA would choose to lie more when ? increases or pG decreases.
5.2 Competitive RA
We now look at the impact of competition on the behaviour of RA by introducing a second RA (RA2). Figure 5 plots the strategy of RA1 for parameter values ( ? , pG , ? ) = (0.5, 0.7, 0.9). Figures 6 and 7 show cross sections of this figure, for different values of q2 and q1 , respectively.
As we can see, the relationship between the reputation and strategy of RA1 remains “u-shaped” as in the monopolistic case. Moreover, as the reputation of RA2 increases, the reputation at which RA1 has minimum x1 , that is, is least likely to lie, also increases. This is not surprising as the disciplining effect is greatest when the reputation of the competing RA (RA2) is close to the reputation of RA1. This is because when the RAs’ reputations are close, it is more likely that the market leadership will change, resulting in more disciplined behaviour. Conversely, if the two RAs have very different reputations, the disciplining effect is relatively weaker.
Moreover, since Figure seven reveals, the methods regarding RA1 are initially decreasing with otherwise apartment when you look at the RA2’s profile, following broadening. Which effect of race was a mixture of the disciplining effect in addition to markets-revealing feeling. The brand new disciplining impression was most powerful in the event the a couple of RA’s reputations was intimate, and weakest if the two RA’s reputations are far aside, which suggests that the probability of a distinction of industry frontrunner is extremely short. As well, industry-discussing feeling is always growing on the contending RA’s profile. In the event the reputation for RA2 try reduced, the business-discussing effect is really short due to the fact RA2 can simply take away a small fraction of business. Since the RA2’s profile actually starts to raise, RA1 has a tendency to rest quicker because disciplining impact reigns over the latest market-revealing impact. Although not, whenever RA2’s character goes beyond a particular peak, the marketplace-revealing impression dominates since the RA2’s character gets greater than just RA1’s. Which, RA1 commonly rest so much more getting highest viewpoints from RA2’s profile, due to the dominance of one’s sector-sharing impact.