Three companies — S&P, Moody’s and Fitch — dominate the world of ratings on trillions of dollars in bonds and debts issued by thousands of corporations, municipalities, and sovereign governments every year.
Their ratings processes and business practices are the standard emulated by the world’s largest insurance rating agency, A.M. Best. And many stock research companies also follow their lead.
So how they grade companies directly or indirectly impacts virtually all investors, big or small.
If they do it objectively, investors can find the path to growing their wealth with safety. If not, investors often have difficulty knowing where the true dangers lie.
Now, thanks to a very insightful article in The Guardian, we learn that Harvard Business School has just released a landmark study that goes to the heart of this matter.
The study, “Implied Materiality and Material Disclosures of Credit Ratings” (available to readers here), documents how the Wall Street ratings agencies have quietly taken a series of steps to drop the claim that their research is “independent.”
It seems, the major rating agencies had two choices.
Choice #1. To change their business model — removing the conflicts of interest that can cause company strengths to be exaggerated, dangers to get hidden, truth to be distorted, the value of research to be devalued, and investors to take more risk than they realize.
Choice #2. To keep their business model largely intact, and instead, quietly change the way they represent themselves — removing references like the word “independent.”
The new Harvard Business School study demonstrates they chose the latter.
I believe that’s very unfortunate.
It can not only make investing riskier for investors, but it can also devalue the ratings of companies that truly merit top grades.
Much like school teachers who routinely give high grades to nearly all their students without regard to merit, I don’t think they’re doing anyone any favors.
The lesson for investors is self-evident: Get your research, ratings and investment recommendations exclusively from a source that’s completely free from conflicts of interest, is truly independent, and proudly declares its independence.
Good luck and God bless!