One resource that all firms need to survive and grow is capital. As discussed in the chapter, entities can obtain a capital mix consisting of debt, equity, and hybrids of debt and equity. Each organization tries to obtain capital at the lowest possible cost.

Various analysts follow public debt and equity issues in order to provide information to the investing public about expected future returns and risk con¬ siderations. Such analysts serve an important role in capital markets because they make information about securities available to investors at relatively low cost. These analysts can have a large impact on security prices.

One of the biggest players in the business of investment analysis is Moody’s Investors Service Inc. One service Moody’s provides is to assign a rating to pending and existing bond issues (debt financing). The impact of these ratings is significant: a higher rating translates into a lower interest rate (and a lower rating translates into a higher interest rate) for the issuing company.

Moody’s has recently caught the attention of government regulators because of its practice of providing unsolicited ratings for pending bond issues. Some bond issuers have suggested that Moody’s bullies them into buying a Moody’s bond rating.

Sometimes, Moody's aggressive tactics seem to induce issuers to include them in their transactions. In 1994, Lehman Brothers Holdings Inc. was preparing to underwrite about $1 billion of bonds for GPA Group, an Irish aircraft-leasing company. Unlike the skimpy fees earned on insured municipals [bonds] deals, these so-called asset-backed transactions could generate as much as $400,000 in fees for ratings companies. Issuers such as GPA rely on their investment advisers to select which firms will rate the securities. And Lehman officials decided to hire S&P and Fitch.

Moody's response: Too bad. Moody's says it had an obligation to bondholders to rate the bonds, especially because GPA was under severe financial distress.

In the end, Lehman decided to include Moody's. Moody's says it persuaded the investment bankers of the value of its ratings. But the bankers say they feared that without all the available information, Moody's would issue a low unsolicited rating and drive up borrowing costs.

[SOURCE: Charles Gasparino, “Triple-A-Dispute: Unsolicited Ratings From Moody’s Upset Some Bond Issuers,” Wall Street Journal (May 2, 1996), pp. Al, A6. Reprinted by permission of The Wall Street Journal, © 1996 Dow Jones & Company, Inc. All Rights Reserved Worldwide.]

As an individual who relies on Moody’s bond ratings to make investment deci¬ sions, evaluate Moody’s practice of providing unsolicited bond ratings from the following:

a. An ethical perspective

b. A risk-management perspective LO2