Credit ratings: strategic issuer disclosure and optimal screening.

The article analyzes a theoretical model of the interaction between a security issuer and a credit rating agency (CRA), focusing on the issuer’s ability to manipulate information observed by the CRA. It demonstrates that stricter CRA screening can paradoxically increase the issuer’s incentives to manipulate information, leading to an equilibrium where optimal screening is pushed toward either lax or stringent extremes. The model also shows that improvements in prior asset quality can unexpectedly raise the incidence of rating errors, and in a two-period extension, more intense screening may increase short-run rating errors due to dynamic reputational effects. These findings highlight the complex feedback between issuer manipulation and CRA screening policies, suggesting that regulatory efforts to improve rating accuracy must consider equilibrium responses from both parties.