Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

P1: TIX/XYZ P2: ABC

JWBT436-bm JWBT436-Baker February 24, 2011 17:26 Printer Name: Hamilton

466 Answers to Chapter Discussion Questions

overall result depends on the joint impact of the two effects and research has

produced mixed results.

CHAPTER 17 RATING AGENCIES AND

CREDIT INSURANCE

1. Determining whether rating agencies do or do not do a good job relative to

what they should accomplish is problematic given the inherent uncertainty

of financial outcomes. This complicates efforts to hold agencies liable for poor-

quality ratings for two reasons.First, considerable difficultyexists in establishing

a minimum quality level. Second, the major rating agencies argue that they have

appropriate quality incentives because they want to preserve good reputations.

If quality cannot be observed even in hindsight, then a reputation for quality is

not meaningful.

The main measure of rating quality that supposedly does what agencies say

the ratings are intended to do is the accuracy ratio. Comparing the accuracy ra-

tios across agencies to arrive at a relative assessment of quality potentially could

support arguments that particular agencies do or do not deserve a reputation

for quality. However, such an approach has received little attention in either

academic literature or in practice.

2. Private users rely extensively on credit ratings to meet regulatory requirements

and as reference benchmarks for agreements and investment mandates. As an

example of the former, insurance companies may choose to have their credit ...