By: Robert Azuayi

The role credit rating agencies played in the financial meltdown of 2008-

2009

Credit rating agencies evaluate the creditworthiness of organisations that issue debt in

public markets and this includes the debts of corporations, non-profit organisations, and

governments, as well as securitised assets which are assets that are bundled together and sold

as a security to investors (Larcker & Miller, 2015).Examples of credit rating agencies are

Moodys, Standard & Poors, and Fitch Ratings.

Throughout the short span of a few months in 2008, 14 trillion dollars of highly rated

bonds fell into junk-status (Scallet & Kelly, 2012). This largely contributed to the economic

decline and the consequent financial meltdown for 2008-2009.However, the role played by the

CRAs in this financial meltdown could be discussed below:

First and foremost, research conducted by Atlman & Rijkan, (2004) revealed that in 2006-2007

surveys on the use of CRAs disclosed that some investors believe that rating agencies are

comparatively slow in correcting their ratings.

Also Utzig (2010), stated that the volume of requests for rating structured finance

products such as mortgage-backed securities and collateralized debt obligations increased

astronomically but the CRAs underestimated the complexity of the rated products leading to

numerous errors. For example, Lehman Brothers had an A rating only a month before its

collapse. CRAs were criticized for worsening the credit crisis by overvaluing complex
mortgage-backed instruments, by underestimating the complexity of those instruments, and by

being slow to downgrade them when their creditworthiness worsened (Bahena, 2010).

Research conducted by De Larosire Group, (2009), revealed that : CRAs lowered the

perception of credit risk by giving AAA ratings to the senior tranches of structured finance

products like collateralized debt obligations (CDOs), the same rating they gave to government

and corporate bonds yielding systematically lower returns, flaws in rating methodologies were

the major reason for underestimating the credit default risks of instruments collateralized by

subprime mortgages and finally credit rating agencies did not adequately address issues relating

to conflicts of interests and analytical independence.

To conclude with, there is therefore, the need for a regulatory body to regulate the

activities of CRAs and the enactment of laws and a careful repeal or amendment of existing

laws to effectively monitor and control the work of CRAs. However CRAs should not be

exclusively held responsible or criticised for largely contributing to the financial meltdown of

2008-2009.This is because investors failed to adequately perform their own due diligence and

often did not look beyond the rating. Many investors did not even read the rating rationale and

disclosure documents that the CRAs published for each rating.

References

Larcker, D. F & Miller, J. I. (2015).Notes on credit ratings. Retrieved from

http://lexicon.ft.com/Term?term=rating-agencies.

Bahena, A. (2010). Notes on CRAs role. Retrieved from

http://www.colorado.edu/AmStudies/lewis/ecology/rolecreditagencies.pdf
 Essay on Appropriate Takeover Defences

Takeover refers to a situation where a company seeks to acquire another to expand

geographically or their customer base. Takeover could be done either through mergers or

acquisitions. Furthermore a takeover could either be friendly or hostile. It is said to be hostile

when the acquisition of control of a target company is done without a contract or a mutual

understanding with the management of the target firm, in other words takeover is done directly

with the shareholders of the target company ignoring the executives (Savela, 1999). On the

other hand, Damodaran (1997), stated that, hostile takeover occurs when bid for the shares of

the target company is placed without informing its board or executives. Any company is likely

to face hostile takeover. However, there are appropriate takeover defences that can be utilised

by the executives or management to safeguard their interest and these could be discussed

below:

Firstly, poison pill is a defense strategy in which the target company offers its

stockholders preferred stock in the merged firm at a highly attractive rate of exchange as a

mandatory consequence of a successful takeover (Pearce & Robinson, 2004).The reason behind

this is to dilute the stock such that the attacking firm loses money on its investment.

Secondly, to prevent unwelcome corporate suitors from acquiring enough stock to take

control of the corporation, flip-in poison pills can be used and with flip-in options, stockholders

are given the right to acquire additional shares in the target company at a substantially lower
price than the current offering (Pearce & Robinson, 2004). For example, All American

Semiconductor announced in 2000 that its board had adopted a flip-in poison pill to be activated

when a pursuer announced a tender offer that would result in its owning 15 percent of the

common stock.

Another defense strategy is the Crown Jewel. This happens when the target company

sell its Crown Jewels (precious assets) to another friendly company and later on, when the

acquiring company withdraws its offer, it will buy back the assets sold to the White Knight at

a fixed price agreed upon in advance (Weston,2001).

Pearce & Robinson (2004), further stated that litigation helps a target company to stall

hostile attacks, but is usually not effective as a long-term deterrent. It involves pursuing a legal

injunction and restraining order against a pursuer to bar that company from acquiring additional

stock until such time as the pursuer can prove legally that the justification for the injunction is

unfounded. During the time the pursuer is preparing and presenting its legal rebuttal, the target

company usually develops other strategies to prevent the takeover.

Lastly, a standstill agreement can be signed by the parties in which the pursuer agrees

not to acquire any more stock of the target firm for a specified period of time in exchange for

the firm paying the pursuer a fee.

References
Pearce, J.A., & Robinson, R.B. (2004).Hostile takeover defences that maximise shareholder

wealth. Business Horizons, 47 (5), 15-24