Hostname: page-component-7c8c6479df-fqc5m Total loading time: 0 Render date: 2024-03-29T07:20:43.659Z Has data issue: false hasContentIssue false

On the information content of ratings: an analysis of the origin of Moody's stock and bond ratings

Published online by Cambridge University Press:  27 April 2011

Berry K. Wilson*
Affiliation:
Lubin School of Business, Pace University

Abstract

John Moody published his first railroad security analysis and ratings manual in April 1909. This study analyzes several current issues by looking back at Moody's original intentions for constructing a ratings system. The study analyzes whether Moody intended his ratings to reflect his private information, or rather, to serve some alternative role, as with monitoring conflicts of interests or realizing informational economies of scale. The study uses an ordinal regression approach to evaluate a set of explanatory variables, constructed from both the manual itself and the panic months of 1907, to test the potential information content of Moody's ratings. At the time of Moody's first rating system, the illiquidity of the US Treasury market forced investors to seek alternative ‘high-quality’ securities. Indeed, Moody rated 38.94 percent of railroad bonds as Aaa, and rated 85.25 percent of railroad bonds as A, Aa or Aaa in his universe of railroad bonds rated. To further test the informational content of Moody's ratings, the study pursues a structural default analysis during the panic year of 1907, which yields results that indicate that the default risk of railroad securities was quite low at the time. These results provide justification for the high overall ratings that Moody assigned to railroad securities, and thus their role as near risk-free securities. Therefore, railroad securities, and Moody's ratings, played a particularly important role in the financial system at the time.

Type
Articles
Copyright
Copyright © European Association for Banking and Financial History e.V. 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Calomiris, C. W. and Gorton, G. (2000). The origins of banking panics: models, facts and bank regulations. In Calomiris, C.W., US Bank Regulation in Historical Perspective. Cambridge: Cambridge University Press.Google Scholar
Commercial and Financial Chronicle, vol. 85-1 (1908). New York: William B. Dana Company.Google Scholar
Elton, E. J., Gruber, M. J., Agrawal, D. and Mann, C. (2001). Explaining the rate spread on corporate bonds. Journal of Finance, 56, pp. 247–77.Google Scholar
Friedman, M. and Schwartz, A. J. (1993). A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press.Google Scholar
Griffiss, B. (1925). The New York call money market. PhD dissertation. Baltimore: Johns Hopkins University.Google Scholar
Hickman, W .B. (1958). Corporate Bond Quality and Investor Experience. Princeton: Princeton University Press.Google Scholar
Hogan, J. V. (1913). Bond investments by national banks. The Journal of Political Economy, 21, pp. 843–9.Google Scholar
Kaplan, R. S. and Urwitz, G. (1979). Statistical models of bond ratings: a methodological inquiry. The Journal of Business, 52, pp. 231–61.Google Scholar
Kemmerer, E. W. (1910). Seasonal Variations in the Relative Demand for Money and Capital in the United States, A Statistical Study. Washington, DC: Government Printing Office.Google Scholar
Kolko, G. (1965). Railroads and Regulation, 1877-1916. Princeton: Princeton University Press.CrossRefGoogle Scholar
Moody, J. (1904). The Truth About The Trusts: A Description and Analysis of the American Trust Movement. New York: Moody Publishing Company.Google Scholar
Moody, J. (1909). Moody's Analyses of Railroad Investments Containing in Detailed Form; An Expert Comparative Analysis of Each of the Railroad Systems of the United States, With Careful Deductions, Enabling the Banker and Investor to Ascertain the True Values of Securities; By a Method Based on Scientific Principles Properly Applied to Facts. New York: Analyses Publishing Co.Google Scholar
Nelson, S. A. (ed.) (1907). The Bond Buyers’ Dictionary. New York: S. A. Nelson & Co., Inc.Google Scholar
Pinches, G. E. and Mingo, K. A. (1973). A multivariate analysis of industrial bond ratings. Journal of Finance, 28, pp. 118.Google Scholar
Pogue, T. F. and Soldofsky, R. M. (1969). What's in a bond rating. The Journal of Financial and Quantitative Analysis, 4, pp. 201–28.Google Scholar
Porter, R. H. (1983). A study of cartel stability: the joint executive committee, 1880-1886. The Bell Journal of Economics, 14, pp. 301–14.CrossRefGoogle Scholar
Prager, R. A. (1989). Using stock price data to measure the effects of regulation: the interstate commerce act and the railroad industry. The RAND Journal of Economics, 20, pp. 280–90.Google Scholar
Seltzer, L. H. and Horner, S. L. (1922). The relation of the percentage of bank reserves of national banks in New York City to the call money loan rate on the New York stock exchange. The Journal of Political Economy, 30, pp. 108–18.CrossRefGoogle Scholar
Smith, R. C. and Walter, I. (2002). Rating agencies: is there an agency Issue?. In Levich, R. M., Majnoni, G. and Reinhart, C. (eds.), Ratings, Rating Agencies and the Global Financial System. Boston: Kluwer Academic Publishers.Google Scholar
Sylla, R. (2002). A historical primer on the business of credit rating. In Levich, R. M., Majnoni, G. and Reinhart, C. (eds.), Ratings, Rating Agencies and the Global Financial System. Boston: Kluwer Academic Publishers.Google Scholar
Ulen, T.S. (1980). The market for regulation: the ICC from 1887 to 1920. The American Economic Review, 70, pp. 306–10.Google Scholar
Vassalou, M. and Xing, Y. (2004). Default risk in equity returns. The Journal of Finance, 59, pp. 831–68.CrossRefGoogle Scholar
Vazza, D. and Cantor, D. (2002). Oh where, oh where have the ‘AAA's gone? S&P US corporate history; 1950 through today. Standard & Poor's Global Fixed Income Research.Google Scholar