Investment Mandates and the Downside of Precise Credit Ratings

Abstract

We theoretically investigate the effect of public information — such as credit ratings and securities analysts’ reports — on investor welfare in the context of delegated asset management. Specifically, we ask: does more precise public information increase investor welfare by decreasing an asset manager’s informational advantage and, thereby, mitigating the agency problem between him and his client? We show, first, that public information does not align incentives and, second, that decreasing the precision of the information is Pareto improving. Interpreting public information as credit ratings, this suggests that widening ratings categories makes everyone better off. Our results are consistent with some empirical facts about asset management fees.