The Information Matrix can be used to examine the rating firms’ business model and the impact of the Transparency Label Initiative on it.

Let’s look at the Matrix below quadrant by quadrant.

Information Matrix

If we are in the Perfect Information quadrant, competition is a function of how good the rating firms are as analysts.  In this quadrant, the rating firms are in direct competition with Experts and the firms have no informational advantage.

In the Information Asymmetry quadrants (Lemon Problem and Antique Dealer Problem), rating firms only participate in the Lemon Problem quadrant.  There the possibility of an informational advantage exists.  Specifically, the rating firms can get information from the seller of the investment that is not available to buyers.

This is actually the rating firms’ current business model.  They frequently meet with companies and receive information that has not yet been disclosed to the market.  In theory, the rating firms then use this information to adjust their ratings.

Rating firms are also active in the Blind Betting quadrant.  They are paid to issue ratings. As the Great Financial Crisis showed, the rating firms are willing to offer a rating even when dealing with an opaque security.

The problem that arises for investors, is knowing whether the rating is for an investment in the Lemon Problem quadrant or the Blind Betting quadrant.  In the former, the rating reflects an informational advantage.  In the latter, the rating reflects the firms’ willingness to issue ratings.

The Transparency Label Initiative helps the investor distinguish between ratings reflecting an information advantage and ratings issued for the money.  Investments with a label that carry a rating reflect an information advantage.  Investments without a label that carry a rating reflect those firms chase for money.