- Overseas operations: What percentage of the firm’s sales, assets, and profits are
from overseas operations, and what is the political climate in the host countries? - Environmental factors: Is the firm likely to face heavy expenditures for pollution
control equipment? - Product liability: Are the firm’s products safe? The tobacco companies today are
under pressure, and so are their bond ratings. - Pension liabilities: Does the firm have unfunded pension liabilities that could pose a
future problem? - Labor unrest: Are there potential labor problems on the horizon that could weaken
the firm’s position? As this is written, a number of airlines face this problem, and it
has caused their ratings to be lowered. - Accounting policies: If a firm uses relatively conservative accounting policies, its
reported earnings will be of “higher quality” than if it uses less conservative
procedures. Thus, conservative accounting policies are plus factors in bond ratings.
Importance of Bond Ratings: Bond ratings are important both to firms and to investors.
First, because a bond’s rating is an indicator of its default risk, the rating has a direct,
measurable influence on the bond’s interest rate and the firm’s cost of debt. Second,
most bonds are purchased by institutional investors rather than individuals, and many
institutions are restricted to investment-grade securities.
- Bond markets
16.1 Corporate bonds are traded primarily in the over- the-counter market. Most bonds
are owned by and traded among the large financial institutions (for example, life
insurance companies, mutual funds, and pension funds, all of which deal in very
large blocks of securities), and it is relatively easy for the over-the-counter bond
dealers to arrange the transfer of large blocks of bonds among the relatively few
holders to arrange the transfer of large blocks of bonds among the relatively few
holders of the bonds. It would be much more difficult to conduct similar
operations in the stock market among the literally millions of large and small
stockholders, so a higher percentage of stocks trade on the exchanges.
- Stocks and their valuation
17.1 The common stockholders are owners of a corporation, and as such they have
certain rights and privileges.
17.2 It is common that stockholders have the right to elect a firm’s directors, who, in
turn, elect the officers who manage the business. In a small firm, the major
stockholder typically assumes the positions of president and chairperson of the
board of directors. In a large publicly owned firm, the managers typically have
some stock, but their personal holdings are generally insufficient to give them
voting control. Thus, the management of most publicly owned firms can be
removed by the stockholders if they decide the management team is not effective.