Moody’s is Damned If They Do and Damned If They Don’t
Guest Post by Jim Kaplan, Chairman, Audit Integrity
The Wall Street Journal article published March 10, entitled “Moody’s Aims to be Ahead of Defaults,” was a real eye-opener, as was the response to the article. Moody’s Corporation has taken a bold and positive step in publishing a list of Companies with the highest probability of default. The Moody’s Bottom Rung consists of the riskiest 15%, approximately, of all Companies they track.
It is interesting to note that Moody’s has been widely criticized for publishing the Bottom Rung, with many Wall Street champions declaring it a “publicity stunt.” I struggle with this response from the marketplace. Moody’s should be encouraged to provide more transparency and information to stakeholders, particularly in view of the legitimate criticism that accepting compensation from the Companies they rate creates a conflict of interest.
Of course, the Companies on the Bottom Rung are unhappy that their solvency has been called into question, but they have no one but themselves to blame for their position. Although not always perfect, Moody’s corporate listing model is objective and has been proven to be statistically significant.The Companies on the list have made poor corporate decisions, have taken on excessive risk, or are simply suffering from an extreme economic downturn.Moody’s should not be pilloried for pointing out the potential consequences of their excesses.
It appears that Wall Street wants to hear only cheerleaders, not Cassandras, regardless of the merit of the message. At the risk of being another Cassandra, I took Moody’s analysis a step farther.This additional step goes beyond Moody’s more traditional analysis.However, I believe, and the evidence supports, the view that poor accounting and governance positions are a strong indicator of future under-performance – including insolvency.
Eliminating 13 non-publicly traded Companies in the top 30 on the list, I took a look at the Accounting and Governance Risk (AGR®) scores of the remaining 17 Companies.
Not surprisingly, 11 of the 17 Companies, or 65% of the sample, had an AGR® rating of Aggressive or Very Aggressive. This distribution is almost double the expected distribution of 35%.
Accounting and Governance risk measures are independent measures not incorporated in Moody’s ratings. I am not surprised, however, that a high correlation exists. Low management integrity, coupled with accounting manipulation, often leads to serious problems including potential default.
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