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The New Masters of Capital
InThe New Masters of Capital, Timothy J. Sinclair examines a key aspect of the global economy-the rating agencies. In the global economy, trust is formalized in the daily operations of such firms as Moody's and Standard & Poor's, which continuously monitor the financial health of bond-issuers ranging from private corporations to local and national governments. Their judgments affect unimaginably large sums, approximately $30 trillion in outstanding debt issues, according to a recent Moody's estimate. The difference between an AA and a BB rating may cost millions of dollars in interest payments or determine if a corporation or government can even issue bonds.
Without bond rating agencies, there would be no standard means to compare risks in the global economy, and international investment would be problematic. Most observers assume that the agencies are neutral and scientific, and that they interpret their role in narrowly economic terms. But these agencies, by their nature, wield extraordinary power and exert massive influence over public policy. Sinclair offers a highly accessible account of these institutions, their origins, and the rating processes they use to judge creditworthiness. Illustrated with a wide range of cases, this book offers a fresh assessment of the role of an often-overlooked institution in the dynamics of modern global capitalism.
eBook
Markets: The Credit Rating Agencies
This paper will explore how the financial regulatory structure propelled three credit rating agencies—Moody's, Standard & Poor's (S&P), and Fitch—to the center of the U.S. bond markets—and thereby virtually guaranteed that when these rating agencies did make mistakes, these mistakes would have serious consequences for the financial sector. We begin by looking at some relevant history of the industry, including the series of events that led financial regulators to outsource their judgments to the credit rating agencies (by requiring financial institutions to use the specific bond creditworthiness information that was provided by the major rating agencies) and when the credit rating agencies shifted their business model from “investor pays” to “issuer pays.” We then look at how the credit rating industry evolved and how its interaction with regulatory authorities served as a barrier to entry. We then show how these ingredients combined to contribute to the subprime mortgage debacle and associated financial crisis. Finally, we consider two possible routes for public policy with respect to the credit rating industry: One route would tighten the regulation of the rating agencies, while the other route would reduce the required centrality of the rating agencies and thereby open up the bond information process in way that has not been possible since the 1930s.
Journal Article
Quality Disclosure and Certification: Theory and Practice
This essay reviews the theoretical and empirical literature on quality disclosure and certification. After comparing quality disclosure with other quality assurance mechanisms and describing a brief history of quality disclosure, we address two sets of theoretical issues. First, why don't sellers voluntarily disclose through a process of \"unraveling\" and, given the lack of unraveling, is it desirable to mandate seller disclosure? Second, when we rely on certifiers to act as the intermediary of quality disclosure, do certifiers necessarily report unbiased and accurate information? We further review empirical evidence on these issues, with a particular focus on healthcare, education, and finance. The empirical review covers quality measurement, the effect of third-party disclosure on consumer choice and seller behavior, as well as the economics of certifiers.
Journal Article
Corruption, Political Connections, and Municipal Finance
We show that state corruption and political connections have strong effects on municipal bond sales and underwriting. Higher state corruption is associated with greater credit risk and higher bond yields. Corrupt states can eliminate the corruption yield penalty by purchasing credit enhancements. Underwriting fees were significantly higher during an era when underwriters made political contributions to win underwriting business. This pay-toplay underwriting fee premium exists only for negotiated bid bonds where underwriting business can be allocated on the basis of political favoritism. Overall, our results show a strong impact of corruption and political connections on financial market outcomes.
Journal Article
Moody's and S&P Ratings: Are They Equivalent? Conservative Ratings and Split Rated Bond Yields
We examine the relative impact of Moody's and S&P ratings on bond yields and find that at issuance, yields on split rated bonds with superior Moody's ratings are about 8 basis points lower than yields on split rated bonds with superior S&P ratings. This suggests that investors differentiate between the two ratings and assign more weight to the ratings from Moody's, the more conservative rating agency. Moody's becomes more conservative after 1998 and the impact of a superior Moody's rating becomes stronger. Furthermore, the differential impact of the two ratings is more pronounced for the more opaque Rule 144A issues.
Journal Article
Distance Still Matters: Evidence from Municipal Bond Underwriting
Using a sample of municipal bond offerings, I find that \"local\" investment banks have substantial comparative and absolute advantages over nonlocal counterparts--locals charge lower fees and sell bonds at lower yields. Local investment banks' strongest comparative advantage is at underwriting bonds with higher credit risk and bonds not rated by rating agencies. These findings suggest that high-risk bonds and nonrated bonds are more difficult to evaluate and market, and that investment banks with a local presence are better able to assess \"soft\" information and place difficult bond issues.
Journal Article
Credit Ratings as Coordination Mechanisms
In this article, we provide a novel rationale for credit ratings. The rationale that we propose is that credit ratings serve as a coordinating mechanism in situations where multiple equilibria can obtain. We show that credit ratings provide a \"focal point\" for firms and their investors, and explore the vital, but previously overlooked implicit contractual relationship between a credit rating agency (CRA) and a firm through its credit watch procedures. Credit ratings can help fix the desired equilibrium and as such play an economically meaningful role. Our model provides several empirical predictions and insights regarding the expected price impact of rating changes.
Journal Article
Forecasting sovereign risk perception of Brazilian bonds: an evaluation of machine learning prediction accuracy
PurposeGiven the importance of credit rating agencies’ (CRAs) assessment in affecting international financial markets, it is useful for policymakers and investors to be able to forecast it properly. Therefore, this study aims to forecast sovereign risk perception of the main agencies related to Brazilian bonds through the application of different machine learning (ML) techniques and evaluate their predictive accuracy in order to find out which one is best for this task.Design/methodology/approachBased on monthly data from January 1996 to November 2018, we perform different forecast analyses using the K-Nearest Neighbors, the Gradient Boosted Random Trees and the Multilayer Perceptron methods.FindingsThe results of this study suggest the Multilayer Perceptron technique is the most reliable one. Its predictive accuracy is relatively high if compared to the other two methods. Its forecast errors are the lowest in both the out-of-sample and in-sample forecasts’ exercises. These results hold if we consider the CRAs classification structure as linear or logarithmic. Moreover, its forecast errors are not statistically associated with periods of changes in CRAs’ opinion of any sort.Originality/valueTo the best of the authors’ knowledge, this study is the first to evaluate the performance of ML methods in the task of predicting sovereign credit news, including not only the sovereign ratings but also the outlook and credit watch status. In addition, the authors investigate whether the forecasts errors are statistically associated with periods of changes in sovereign risk perception.
Journal Article
THE RELATIONSHIP BETWEEN INTEREST RATES, FINANCIAL RATIOS, AND BOND RATINGS WITH PROFITABILITY AS A MEDIATING VARIABLES IN NON-FINANCIAL SECTOR COMPANIES IN INDONESIA
During the latest decades, regional creativity has often been considThis study seeks to investigate the relationship between interest rates, liquidity, and leverage to non-financial companies in Indonesia who have issued bond securities between 2018 and 2023 with profitability as an intervening variable. Panel data regression analysis and path analysis are used in the study to explore the connections between the variables, both directly and indirectly. According to the results, bond ratings are heavily affected by interest rates, but liquidity does not appear to play a major role. Moreover, leverage appears to have a positive effect on bond ratings. Moreover, profitability is significantly influenced by interest rates, while leverage has a detrimental effect on profitability. The study suggests that there is a slight influence of profitability on the connection between interest rates and bond ratings, but not for liquidity or leverage. Interest rates are found to have a significant positive effect on bond ratings, whereas liquidity and leverage have minor direct impacts. These findings contribute to investors in making bond investment decisions, as well as for companies in optimizing their capital structure to improve bond ratings. This study suggests further development by expanding the coverage of other industry sectors and adding variables such as corporate governance and macroeconomic indicators to increase external and internal validity
Journal Article