When Moody’s and S&P; Speak, Corporate America Listens

Corporate titans and government officials cringe before them.

These two Wall Street companies are far from household names, but when they flex their muscles they can influence businesses to sell divisions, lay off employees or slash spending.

The companies are the two major credit-rating agencies, Moody’s Investors Service Inc. and Standard & Poor’s Corp. Several recent events have again demonstrated their power over corporate America.

Because a credit rating affects the rate of interest a company must pay to borrow money, it is a powerful weapon. By threatening to lower a company’s rating, Moody’s and S&P; can influence it to take steps to strengthen its finances.

Moody’s and S&P; have a similar influence over state and local governments that issue bonds. And when a government has to pay more interest, it may be forced to increase taxes or cut services.

Recently, Moody’s showed its strength by persuading Shearson Lehman Hutton Inc. to restructure its operations.

Shearson, threatened with a rating downgrade, announced that it would raise about $850 million through private stock placements to bolster its finances. The brokerage also sold a financial counseling subsidiary to American Express Co., Shearson’s largest stockholder, netting $56 million.

The power of the credit-rating agencies was shown more graphically late last month when Moody’s downgraded its rating of debt issues of RJR Nabisco, the food and cigarette giant taken private in a record $24.53-billion buyout last year. In addition, Moody’s assigned a lower-than-expected rating to an upcoming $1.25-billion RJR Nabisco bond issue.

Moody’s action sent RJR Nabisco’s junk bonds into a tailspin, reducing the market price of some issues by 10%. It also rattled the entire high-yield bond market and briefly depressed stock prices.

Harold Goldberg, chairman of Moody’s corporate rating committee, said the company does not consider the potential market impact of a ratings change. But, he said, it is not oblivious to that factor.

“Our role in the marketplace is that of an independent provider of credit opinions,” he said. “If we were to withhold information that we think is relative we would be abusing our role.”

The market reaction to ratings changes usually is predictable, Goldberg said. However, with RJR Nabisco, he added: “We did not expect the impact on the markets we saw.”

Marshall Blume, a professor of finance at the University of Pennsylvania’s Wharton School, said the impact of a ratings change depends on whether it is expected by the markets.

Many changes are expected based on information a company has disclosed publicly, so the price of its bonds already reflect the expected upgrade or downgrade, he said. But changes that come out of the blue pack the wallop of the RJR Nabisco move.

Companies pay the ratings agencies to judge their securities. They also provide the agencies confidential information on their finances and business projections.

When Moody’s has concerns about a company it rates, it notifies it and asks what its plans to do about it, Goldberg said. Once the company responds, “we would give them feedback.”

“I don’t call that a negotiating process myself by rather an interchange of information,” he said. “It’s based on mutual trust.”

Once a ratings decision is made, it is released to the company and public simultaneously, he said. Goldberg said there is no appeal process, but that all ratings are continuously reevaluated.

Goldberg said Moody’s is aware of its influence in the marketplace.

“We wouldn’t be providing these opinions if we had no influence,” he said. He said the ratings process has “been tested, it’s been relied upon and it’s quite material to the total capital formation process. We take this role quite seriously.”

Goldberg said the two major ratings agencies are not a monopoly. Major buyers of securities and brokerages have their own in-house ratings systems, he said. In addition, several smaller rating agencies provide competition.

Also, he said, ratings are just one factor that determines the price and market for securities.

The treasurer of a major corporation, who spoke on condition of anonymity, said his company often disagrees with ratings agencies over facts and interpretations of his company’s finances. He said the agencies are not always open to such discussions and that some appear arrogant about their role.

“The function that they perform, performed right, is a useful one,” he said. “I get a little concerned about the fact . . . that somebody who doesn’t know your business very well can have that much power over it.”

Blume said the ratings agencies are kept in line by the need to maintain their reputations.

“If they were to abuse their power they would no longer be credible,” he said. “They’re not capricious.”

Still, they are not spared criticism. The Wall Street Journal editorialized last year that the agencies were asleep while the finances of Massachusetts crumbled.

The Journal said the credit agencies failed to give investors in Massachusetts bonds an advance warning of the state’s impending financial crisis, which eventually resulted in a drastic lowering of its bond rating. The Journal cited similar delays in foretelling the doom at the Washington Public Power Supply System, whose default on $2.25 billion in bonds in 1983 was the largest in municipal bond history.

The Journal said the credit agencies suffer from “a fundamental conceit: that they are smarter than the marketplace.”