Should a credit-rating agency be a public company, with all the commitments to shareholders -- as distinct from commitments to clients and the public-at-large -- that this status entails?
When Moody's, the U.S.'s second largest credit-rating agency, became a public corporation in 2000 upon being spun off by
That could change, though, as a result of a paper to be presented next month at the annual meeting (in
Examining in detail Moody's bond ratings between 2001 and 2010, and comparing them to ratings of the same bonds by the nation's largest rating agency, Standard & Poor's (which is not a free-standing public company), the study finds a tangible bias favoring firms in which Moody's two largest shareholders,
A collaboration of
In contrast to this finding, the authors "do not find evidence of favorable treatment by Moody's toward the large investees of its post-IPO long-term large shareholders (i.e.,
Further, in probing whether Moody's favorable treatment toward its owners is observed in its rating of outstanding bonds as well as new issues, the researchers find that "Moody's is slower than S&P by 71 days in downgrading bonds related to its long-term large shareholders," namely
The professors find an analogous pattern in the rating of commercial mortgage-backed securities (CMBS's), which were the fastest-growing segment for credit-rating agencies during the sample period of 2001 through 2010. "Though Moody's is on average tougher than S&P," they write, it "is significantly less tough on related tranches" -- that is, CMBS's issued by the financial firms in which
As would be expected, the study goes to considerable lengths to test the strength of its findings. Suppose, for example, the differences noted between the ratings of S&P and Moody's are due to the nature of the raters' analyses (such as differing importance assigned to leverage or stock-price volatility) rather than to the bias of Moody's? To guard against any such misreading, the authors control for these and diverse other factors that are likely to affect credit ratings.
In addition, they compare Moody's ratings to those of Fitch, the nonpublic firm that is the U.S.'s third largest credit-rater, and find a pattern of Moody's favoritism similar to that which emerges in comparisons to S&P.
The professors also assess possible rating favoritism at S&P, which, while not a free-standing public company, like Moody's, is a subsidiary of publicly traded
"S&P is no Mother Theresa," comments Prof. Rajgopal. "But its biases are less extensive than those of Moody's."
In conclusion, the authors note that "the
Asked to elaborate, Prof. Rajgopal demurs, observing that detailed recommendations are beyond the scope of the study. But he does express agreement with an assessment of the current situation made by
To which Prof. Rajgopal adds that what gives this issue special urgency is the quasi-regulatory role of credit ratings. "The regulatory capital requirement for banks and insurance companies varies with the credit ratings of the securities they hold," he says, "and money-market funds can hold only a minimal number of securities that are not rated. Laxity arising from market pressures stemming from public ownership of these agencies represents a threat to the entire financial system and has the potential to seriously erode market confidence."
The paper, entitled "Does it matter who owns Moody's?" will be among hundreds of scholarly presentations at the
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