Abstract We consider a model in which a security issuer can manipulate information observed by a credit rating agency (CRA). We show that stricter screening by the CRA can sometimes lead to increased manipulation by the issuer. Accounting for the issuer’s behavior pulls optimal CRA screening toward the extremes of laxness or stringency. Surprisingly, an improvement in prior asset quality can result in more rating errors. In a two-period version of the model, stricter screening can result in more short-run rating errors. Our results suggest complex interplay between issuer and CRA behavior, complicating the evaluation of CRA policy effectiveness.

Abstract Despite the prevalence of private equity (PE) buyouts of private firms, little is known about how these transactions create value. We provide evidence that PE acquirers disproportionately target private firms with weak operating profitability and those that have growth potential but are highly levered and dependent on external financing. Target firms grow rapidly post-buyout, especially those undertaking add-on acquisitions, and profitability increases for both profitable and unprofitable targets. Our evidence suggests that PE acquirers create value by relaxing financing constraints for firms with strong investment opportunities and improving the performance of weak firms, while financial engineering plays a limited role.