Credit Rating Agencies

With the current unpredictability and volatility of the global financial system, investors are making use of all the tools at their disposal to assist them in their investment decision making. While critics may point out shortcomings of credit rating agencies (CRA), they are nevertheless seen as being useful in gauging the financial health and credit-worthiness of various entities, including companies, non-profit organizations, state and local governments, and even national governments. The independent measurement of relative credit risk provided by credit rating agencies is believed to increase the scope of investment options for investors and can increase market efficiency and supply of risk capital, leading to stronger economic growth.

There are a number of credit rating agencies for corporations and government entities operating in the United States, but only three have the approval of the Securities and Exchange Commission – Standard & Poor’s, Fitch Inc. and Moody’s Investors Service – being designated as nationally recognized statistical-rating organizations (NRSROs). However the failure of credit rating agencies to identify impending calamity related to the current economic crisis has prompted the SEC to call for an investigation into a number of issues, such as anti-competitive practices regarding the limited the number of NRSROs, as well as possible conflicts of interest created by companies paying CRAs that publish their debt rating. It is generally agreed, however, that any role CRAs may have knowingly or inadvertently played in the meltdown of the economy is likely to be minor.

Using the Enron scandal as an example, critics note that CRAs don’t react quickly enough in downgrading troubled companies’ ratings. Although CRAs had known for some time that Enron was in trouble, four days before Enron went into bankruptcy, it still had an investment grade credit rating. Another cause for concern is the close relationship that some large corporate credit rating agencies have with the management of the companies they rate, bringing an element of doubt regarding the impartiality of credit ratings. CRAs are known to work hand-in-hand with companies, advising them on various strategies to make use of in order to maintain their desired credit rating. Credit ratings can be so influential when it comes to investment decisions, that companies have been known to model their management strategies in a manner that puts undue focus on credit ratings, sometimes at the expense of long term goals, such as research and development, the environment and even loyalty to employees. Ultimately, though, credit rating agencies are not infallible and should be used in conjunction with other investment tools when making decisions.