Split Ratings and Differences in Corporate Credit Rating Policy between Moody's and Standard & Poor's

Date01 November 2014
Published date01 November 2014
The Financial Review 49 (2014) 713–734
Split Ratings and Differences in Corporate
Credit Rating Policy between Moody’s and
Standard & Poor’s
Michael Bowe
Manchester Business School, University of Manchester
Waseem Larik
Bank of Montreal
This paper investigates split credit ratings awarded by Moody’s and Standard & Poor’s
(S&P) to U.S. corporations. Bivariate probit model estimates, analyzing 5,238 firm-year ob-
servations from dual-rated S&P 500/400/600 index-constituent corporations, indicate firm-
specific financial and governance characteristics predict split ratings. Large,profitable compa-
nies with enhanced interest coverage, a greater percentage of independent directors, and more
institutional investment are less likely to receivesplits. Moody’s appears more conservative in
its evaluations, assigning lower ratings to smaller, less profitablecompanies with low interest
coverage. Moody’s also associates external, independent constraints on managerial autonomy
with a higher corporate credit standing relative to S&P.
Corresponding author: Manchester Business School, University of Manchester, Booth Street West,
Manchester M15 6PB, UK; Phone: +44 161 306 3407; Fax: +44 161 275 4023; E-mail:
We gratefully acknowledge the comments of Ralf Becker, Pedro Gomes, Owain ap Gwilym, Stuart
Hyde, Christopher Mann, Khelifa Mazouz, Philip Rother, Brahim Saadouni, Antonios Siganos, Kostas
Stathopoulos, Alex Taylor, Randall Valentine, the editor, Bonnie Van Ness, and anonymous referees of
this journal, as well as participants at the 2011 US Academy of Business conference and 2012 British
Accounting and Finance Association conference on earlier versions of this paper.
C2014 The Eastern Finance Association 713
714 M. Bowe and W. Larik/The Financial Review49 (2014) 713–734
Keywords: corporate ratings, split credit ratings, governance, ratings policy
JEL Classifications: G24, G28, G38
1. Introduction
Moody’s and Standard & Poor’s(S&P) dominate the global credit ratings indus-
try.1Indeed, financial services regulations2endorse their privileged position, sanc-
tioning the two major credit rating agencies (CRAs) preferential access to proprietary
corporate information in relation to other investment professionals. Notwithstanding
such advantages, Moody’s and S&P commonly disagree in their assessment of credit
quality and often assign split credit ratings to a corporation or a specific security
issue. Evidence suggests that approximately 20% of rated U.S. corporate bond issues
receive category-level split ratings, while around 50% of subratings or notch-level
ratings are splits3(Ederington, 1986; Jewell and Livingston, 1998; Livingston, Wei
and Zhou, 2010).
The economic and financial consequences arising from the award of a split
rating to a corporation are potentially significant. Financial market regulations can
restrict investors from investing in firms or securities that do not possess investment
grade ratings from the two major CRAs. Asset pricing studies reveal the award of
split ratings affects yields on bond issues trading in the secondary market, albeit
there is no clear consensus as to the direction of influence. Liu and Moore (1987)
allege that bond yields on split-rated issues reflect the lower of two ratings, while
Hsueh and Kidwell (1988) and Reiter and Ziebert (1991) maintain that they are
determined by the higher rating. Livingston, Wei and Zhou (2010) conclude split-
rated bonds average a 7-basis-point yield premium over congruent-rated bonds of
comparable credit risk. Jewell and Livingston (1998) and Gilloon (2010) propose
that the influence of split ratings on yields depends on the investment time horizon.
Surveys of U.S. and European fund managers corroborate these contrasting findings.
Cantor, Thomas and ap Gwilym (2007) find that 16% of the responding U.S. fund
managers make portfolio decisions using the higher of the two ratings, while 22% use
1Over our sample period, the combined market share of Moody’s and S&P is around 80%. “Rating the
rating agencies,” The Economist, May 31, 2007.
2Regulation Fair Disclosure (FD), implemented on October 23, 2000, prohibits U.S. public companies
from making selective, nonpublic disclosures to favored investmentprofessionals. This regulation has a
specific exclusion enabling rating agencies to access such nonpublic information.
3On the basis of S&P/Moody’s rating descriptors, a category-level split differentiates AA/Aa from both
A/A and AAA/Aaa, but not from AA+/Aa1 and AA/Aa3, while AA/Aa2 is distinct from both the
latter ratings in a notch-level split. S&P and Moody’s introduced notch-level ratings in 1974 and 1982,
respectively.As indicated, notch rating categories are given plus and minus symbols by S&P,and numerical
categories 1, 2, and 3 in the case of Moody’s.

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