Bond Quality Rating Changes for Electric Utilities: A Multivariate Analysis

Most bond issues of large utility companies are rated for quality by at least two of the three rating agencies. Bond investors individuals and institutions are concerned not only with original ratings of an issue but also with future ones. Since a rating change will affect prices of the outstanding bonds as well as interest rates and marketability of new issues, it may be a cause of portfolio readjustment for investors as well as a reason for the utility to reconsider its capital budgeting policies. Each rating agency maintains that models based on financial statements or data bases cannot replicate its ratings [4, 7]. Nevertheless, studies have explained bond quality ratings by using financial statement data [9, 19, 21, 25] and related bond quality ratings to systematic risk [15], prices [10], bond yield [26], and market-determined risk measures [22]. Several scholars have examined the impact of rating changes on borrowing cost [11] and on price adjustments [8, 12, 20]. No work has been uncovered, though, that centers upon forecasting rating changes by the various rating agencies. The purpose of this paper, therefore, is to investigate whether or not a multivariate discriminant model that incorporates the recent levels, past trends, and instability of financial ratios can explain and predict the quality rating changes of electric utility bonds. We used 1971 as a starting point because bond rating changes were rare before then. In 1971, there were no quality rating changes announced by Moody's for industrial or utility bonds graded B or above. With rising interest rates and the environmental problems