Anatomy of a ratings change

I document the frequency with which credit rating changes result from changes in the firm's operating environment versus changes in capital structure controlled by management. I find that management action plays a significant role in credit rating changes. Twenty-eight percent of downgrades and 44% of upgrades have a substantial management influence. The frequency of management impact on credit ratings shows the limitations of credit risk modeling using structural models that assume constant capital structure. Even the cases in which firms are downgraded across the investment/speculative grade threshold can be driven by management actions rather than operating or economic conditions. Twenty-two percent of the observations of firms newly downgraded to speculative grade are entirely attributable to management action. The frequency of management-driven changes exhibits yearly and industry variation.