Firm credit ratings - Free Essay Example

Sample details Pages: 5 Words: 1605 Downloads: 5 Date added: 2017/06/26 Category Finance Essay Type Argumentative essay Did you like this example? While corporate governance can affect a companys creditworthiness and equity attractiveness, the score does not itself express an opinion about a companys credit quality or share valuation (Standard Poors 2002, p. 5). Thus, while it is clear that SP views a firms corporate governance as an important input into its assessment of a firms creditworthiness, the quality of corporate governance is not a sufficient statistic for determining a firms credit rating. Moreover, which elements of governance are most important in assessing firms creditworthiness is very much an open question. Firm credit ratings are determined by rating agencies assessment of the probability distribution of future cash flows to bondholders, which in turn, depends on the future cash flows to the firm. Under the assumption of normality, this reduces to estimating the mean and variance of a firms future cash flows. Don’t waste time! Our writers will create an original "Firm credit ratings" essay for you Create order A firms creditworthiness is determined by assessing the likelihood that its future cash flows will be sufficient to cover debt service costs and principal payments. As the mean of the future cash flow distribution shifts downward or the variance of future cash flows increases, the likelihood of default increases and the firms credit rating will decline. Within the Jensen and Meckling (1976) agency theory framework, governance features impact credit ratings by controlling agency costs that result from conflicts between managers and all stakeholders as well as between bondholders and shareholders. Many of the governance features we examine are designed to reduce the agency conflict between managers and all stakeholders. Governance mechanisms that provide independent monitoring of management promote effective managerial decision making that increases firm value (e.g., investing in positive NPV projects) and guard against opportunistic management behaviour that decreases firm value (e.g., over-consumption of perks, overcompensation, shirking and over-investing). Governance mechanisms promoting better managerial decision making and limiting opportunistic behaviour benefit all stakeholders. We posit that if governance is weak, the firms distribution of future cash flows will shift to the left relative to what it would be with effective go vernance. This increases the likelihood of default resulting in a lower credit rating. Shareholder and bondholder interests are generally aligned when better monitoring of management occurs. However, certain elements of corporate governance have a more ambiguous impact on bondholders (FitchRatings, 2004). For example, some features of governance can place greater power in the hands of shareholders (or selected subsets of shareholders) who can assert their influence to obtain preferential treatment at the expense of other stakeholders (e.g., greenmail or targeted share repurchases [Dann and DeAngelo, 1983]). Alternatively, shareholders can use their power to encourage management to undertake risky investments or engage in ownership changes that can harm bondholder interests. Taking on risky projects presents the classic conflict between bondholders and shareholders that can increase the likelihood of default, resulting in lower credit ratings. Some of the governance features we consider below (e.g., shareholder rights) have the potential for effecting wealth transfers between bondholders and shareholders. Hence, while beneficial from the shareholders perspective, certain governance features potentially can be harmful to bondholders. Or, alternatively, governance features that weaken shareholder rights may actually be viewed positively from the bondholders perspective. In sum, the governance variables introduced in the next section proxy not only for the agency Conflicts between outside stakeholders (stockholders and bondholders) and management, but also potential conflicts between bondholders and stockholders that can result in wealth transfer effects between these two stakeholder groups. The S P framework encompasses the major relevant dimensions of corporate governance and provides a useful template for evaluating firms corporate governance mechanisms and structure. The SP framework is comprised of four major components, which we now discuss along with the empirical proxies used to capture the major elements within each category. Ownership Structure and Influence Typically, corporate governance is viewed from the perspective that publicly traded firms have dispersed shareholders who demand governance to protect their residual claims. Ownership structure is an important element of corporate governance, especially when there are large block holders or significant institutional ownership in the firm. block holders or institutional investors that hold large debt or equity positions in a company are important to a well functioning governance system because they have the financial interest and independence to view firm management and policies in an unbiased way, and they have the power to put pressure on management if they observe self-serving behavior. Financial Stakeholder Rights and Relations Financial stakeholder relations reflect a companys treatment of its debt and equity stakeholders and the balance of power between these stakeholder groups and management. A key element of this dimension of corporate governance is whether the company maintains a level playing field for corporate control and whether it is open to changes in management and ownership that provide increased shareholder value. However, provisions that provide increased shareholder value do not necessarily translate into increased bondholder value as we will see. Takeover defenses and other restrictions of shareholder rights like staggered terms of directors, golden parachutes for management, supermajority voting requirements for approval of mergers and ownership changes, and limits on shareholders ability to meet and act places more power in the hands of management vis-agrave;-vis shareholders and can make it difficult to remove management. Governance mechanisms tilted in favor of management can lower over all firm value, resulting in losses to both shareholders and bondholders. However, giving greater power to shareholders to determine changes in ownership control does not necessarily always make bondholders better off (FitchRatings, 2004). Financial Transparency and Information Disclosure Transparent financial reporting is critical to reducing the information asymmetry between the firm and its capital suppliers. Sengupta (1998) conjectures that firms with more timely and informative disclosures are perceived to have a lower likelihood of withholding value-relevant unfavorable information, and, as a result, are expected to be charged a lower risk premium by creditors. Consistent with this prediction, he finds that firms with higher AIMR disclosure ratings enjoy a lower effective interest cost of issuing new debt. As AIMR disclosure ratings are no longer available, we use a marketbased proxy for financial transparency and timeliness of disclosure that we label FIN_TRANS. We using a sample of 1500 firms during the 1990s, Gompers, et al. find that taking a long position in firms with the strongest shareholder rights and a short position in firms with the weakest shareholder rights yields an average abnormal return of 8.5 percent per year. Moreover, they find that firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and lower corporate acquisitions suggesting that these firms largely avoided the over-investment problem that often occurs with entrenched management and weak governance (Jensen, 1993). To validate this construct, we correlate FIN_TRANS measured in earlier periods with AIMR disclosure ratings of similar periods and find the correlations to be significant in the expected direction. Describe the measurement of FIN_TRANS in detail in Section IV. In brief, FIN_TRANS is the squared residual from regressing returns on earnings allowing for separate intercepts and slopes for profit and loss firms (Gu, 2002). Earnings that better articulate with market returns are deemed to be more transparent and timely in that they better reflect the economic events that are priced by the market. A high squared residual indicates that earnings are less transparent/timely. To facilitate the interpretation of this variable, we multiply it by negative one and predict a positive relation with firms credit ratings. The reliability of financial information is due, in part, to the quality and integrity of the audit process. To proxy for the quality and integrity of the audit process, we use three measures: (1) the total fees (audit plus non-audit) charged to the client firm divided by the total revenues of the audit firm (TOTFEES); (2) %AUD_IND is the percentage of the audit committee made up of outside independent directors; and (3) a dummy variable, FIN_EXPERT coded one if the firms audit committee has at least one individual deemed to be a financial expert, and zero otherwise. Using the attributes of a financial expert set forth by the Securities and Exchange Commission (SEC, 2003) this variable is coded one if the audit committee has an outside independent director that is a CPA or who has experience as a chief financial officer of another company. Board Structure and Processes This component of corporate governance deals with such things as: (1) board size and composition in terms of proportion of inside, outside and affiliated directors; (2) board leadership and committee structure; (3) how competent and engaged board members are; (4) whether there are a sufficient number of outside independent directors on the board that represent the interests of all stakeholders, and how those members are distributed across the various committees; and (5) whether board members are remunerated and motivated in ways that ensure the long-term success of the company. The first three elements address the boards role and ability to provide independent oversight of management performance and hold management accountable to stakeholders for its actions. Boards often delegate oversight of key functions or decision making to standing committees-e.g., audit, compensation, nominating or governance, finance and investment. These committees, made up of subsets of board members, meet separately from the full board and generally have specific, narrowly defined functions. Finally, and more germane to bondholder interests, Bhojraj and Sengupta (2003) posit that firms with a greater proportion of outside directors on the board have stronger governance and face reduced agency risks, which should lead to superior bond ratings and lower debt yields. Consistent with this conjecture, they find that firms with a higher proportion of nonofficer directors enjoy lower bond yields and higher ratings on new bond issues.

How Communicable Diseases Can be Broken at a Link Within...

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Take The Gap Year Essay - 1326 Words

Take the gap year Every year there are millions of students who graduate high school and the majority will go to college. According to the United States Bureau of Labor Statistics, â€Å"Of the 3.0 million youth age 16 to 24 who graduated from high school between January and October 2015, about 2.1 million (69.2 percent) were enrolled in college in October.† (â€Å"College† par 3.) The other nine hundred thousand students will either delay college or have decided to never enter college. Taking time off between your high school graduation and the start of college, or during college, is considered a gap year. This time off can be structured, such as traveling for volunteering. On the other hand, it can be unstructured, such as leisurely activities. Some of the most prestigious colleges in the United States encourage taking a gap year, including Harvard, Yale, Princeton, and Cornell. â€Å"For nearly 40 years, Harvard has recommended this option, indeed proposing it in the letter of admission.† (Fitzsimmons et al. Par. 21). There are a great deal of benefits to students delaying the start of college and taking a gap year. One of those valuable benefits is the ability of gaining life experience. When taking a gap year, the student may have the ability to travel outside their normal life. Traveling gives an individual a new insight and perspective into the world. According to Bob Clagett, the director of college counseling at St. Stephen s Episcopal School, â€Å"students who veShow MoreRelatedThe Role Of Gap Years Essay1220 Words   |  5 PagesThe role of gap years to earn a higher education is a controversial idea. Many people feel it is important to take on Europe s natural participation in the gap year after high school. 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Afghan Contract Activity Procurement Process

Question: Discuss about theAfghan Contract Activity for Procurement Process. Answer: Issue in Procurement Process The specific failure that accounts in the Afghan Contract procurement process is due to misleading of the speculative business; as the Afghan Contract was not able to compile the resources and legal actions and made fraudulent representations of the shipments of Illegal Chinese Ammunitions while making false invoices deliveries to the bidders (Committee on Oversight and Government Reform, 2008). Moreover, the low quality ammunitions seem to be a common phenomenon, which made Afghan Contract as a failure in execution and oversight. On the other hand, these actions lead to a major change when criminal charges were imposed due to the disruption in procurement activities (Lawson 2011). Conversely, according to the Committee investigation, the contract has not only been suspected of illegal trafficking but also has made illegal false statements and claims to the Army. Moreover, these claims have been specifically on the false invoices for ammunition that have not been delivered because they were concealed (Kramer 2012). As a result, there has high rate of rejection of orders, failures and returns and complaints from the bidders (Committee on Oversight and Government Reform, 2008). Possible Solutions On the other hand, the Afghan contract need to deal with its ethical environment maintenance. Moreover, it is important that it follows and maintains control procedures with proper audit and review of the security proceedings. The solution can also be effectively solved by providing proper contract as well as tender documentation based specifications. Moreover, the regulation of mandatory requirements can be delivered by establishing baseline with adequate training and performance management (Aung 2013). References Aung, K. (2013).Checklist for the potential risks in procurement process. linkedin.com. Available at: https://www.linkedin.com/pulse/20140913100310-341758161-checklist-for-the-potential-risks-in-procurement-process [Accessed 9 Sep. 2016]. Committee on Oversight and Government Reform. (2008).The AEY Investigation. Available at: https://democrats.oversight.house.gov/sites/democrats.oversight.house.gov/files/migrated/20080624102358.pdf [Accessed 9 Sep. 2016]. Kramer, M. (2012).The Most Common Procurement Fraud Schemes and their Primary Red Flags | International Anti Corruption Resource Center. Iacrc.org. Available at: https://iacrc.org/procurement-fraud/the-most-common-procurement-fraud-schemes-and-their-primary-red-flags/ [Accessed 9 Sep. 2016]. Lawson, G. (2011).'War Dogs' True Story: How Two U.S. Kids Became Arms Dealers - Rolling Stone. Rollingstone.com. Available at: https://www.rollingstone.com/politics/news/the-stoner-arms-dealers-20110316 [Accessed 9 Sep. 2016].