Most bloggers are familiar with lots of examples of accruals management research.  We are also seeing studies on other sorts of financial reporting manipulations, including real earnings management or classification shifting.

   The NY Times had an article which discusses the credit rating agencies and their role in the recent financial crisis.  In a move to be transparent, the rating agencies disclosed the formulae they use to establish ratings.  Perhaps not surprisingly, once companies learned which deal characteristics were more likely to garner an AAA rating, products were modified to achieve higher ratings.  As examples:

   “…a top concern of investors was that mortgage deals be underpinned by a variety of loans. Few wanted investments backed by loans from only one part of the country or handled by one mortgage servicer. But some bankers would simply list a different servicer, even though the bonds were serviced by the same institution, and thus produce a better rating, former agency employees said. Others relabeled parts of collateralized debt obligations in two ways so they would not be recognized by the computer models as being the same, these people said.
   “Banks were also able to get more favorable ratings by adding a small amount of commercial real estate loans to a mix of home loans, thus making the entire pool appear safer.
   “Sometimes agency employees caught and corrected such entries. Checking them all was difficult, however.  ‘If you dug into it, if you had the time, you would see errors that magically favored the banker,’ said one former ratings executive, who like other former employees, asked not to be identified, given the controversy surrounding the industry. ‘If they had the time, they would fix it, but we were so overwhelmed.’”

   Two questions: I wonder if a ratings agency might hire an academic fellow to do a systematic study of manipulation within its proprietary database of ratings applications?  If the rating agencies had kept quiet regarding the yard stick they used to measure credit quality, would the ambiguity have led to less games playing?