Opposition to shareholder value: bond rating agencies and conflicting logics in corporate finance

Opposition to shareholder value: bond rating agencies and conflicting logics in corporate finance Abstract Research examining the financialization of American firms has largely concentrated on the rise in the shareholder value orientation (SVO) among corporate managers and the subsequent adoption of specific corporate strategies. However, this article argues that in theories of finance, the SVO is a manifestation of only one of the logic models followed by investors—that of equity investment. Equally important, according to these theories, is the logic of debt investment which is often at odds with the logic of equity investment. This article demonstrates that overlooked influential actors in the field of corporate finance that subscribe to this logic of debt investment, i.e. bond rating agencies, are actively discouraging the spread of shareholder value-driven corporate practices via the bond rating process. This is important given the shift to bond financing as the primary form of corporate finance in the USA. 1. Introduction Economic and organizational sociologists have placed a major emphasis on studying the influence of the financial industry on the evolution of the American corporate firm during the last half century. However, the literature examining the intersection of financialization and corporate governance in the USA has almost exclusively focused on the growth of the shareholder value conception of control (Lazonick and O’Sullivan, 2000; Fligstein, 2001; Davis, 2005, 2009, 2013; Dobbin and Zorn, 2005; Ho, 2009; Dobbin and Jung, 2010; Gunnoe and Gellert, 2010; Carruthers and Kim, 2011; Tomaskovic-Devey and Lin, 2011; Lazonick, 2013; Van der Zwan, 2014; Jung and Dobbin, 2015). Though there has been some empirical examination of the spread and contestation of a shareholder value orientation (SVO) within coordinated market economies (Rose and Mejer, 2003; Fiss and Zajac, 2004; 2006; Sanders and Tuschke, 2007; Yoshikawa etal., 2007; Bezemer etal., 2015), there has been little examination of resistance to this dominant logic in US corporate finance. This article demonstrates that there are indeed powerful social actors in the field of corporate finance that actively discourage the spread of SVO practices in US corporate governance. Economic theories of corporate finance have long argued that the interests of equity investors and debt investors are not necessarily aligned and can often be at odds. Yet, the sociological and organizational literature has continued to largely focus on the influence of SVO policies in corporate governance which reflect the interests of equity investment over debt investment. Despite the decline in corporate bank loans in the USA since the 1970s, there has been a dramatic rise in corporate debt financing via bond issues to the point where bonds have become the dominant form of corporate financing (Sinclair, 2005; Schwarcz, 2017). As debt financing increasingly continues to drive corporate growth in the USA, the power of bond rating agencies, which represent the interests of debt investors, has increased. Drawing on economic theories from finance, this article argues that the SVO approach to corporate governance only reflects one-half of the investment logic driving corporate financing despite its centering in sociological research on financialization. Further, it empirically demonstrates that there are influential financial actors who openly resist isomorphic SVO-driven corporate practices studied in the sociological literature. Bond rating agencies, which possess coercive power over firms and ultimately reflect the interests of debt holders, negatively sanction firms that engage in popular SVO practices. Given the shifting ratio of debt to equity financing, this research demonstrates the need for an expanded inquiry into the logics driving corporate governance in order to achieve a more complete picture of how financialization is shaping the US corporate landscape. This article begins by reviewing the literature from economic sociology that documents the expansion of financialization and shareholder value oriented practices in US corporate governance. It goes on to locate the SVO model in a specific logic of corporate finance which we refer to as the ‘logic of equity investment’, and highlights the conflicting ‘logic of debt investment’, which has been mostly overlooked outside of the finance literature and stands counter to shareholder value oriented management. The article then emphasizes the importance of bond rating agencies as powerful social actors, who influence corporate governance. It is argued that given their position in the field of corporate finance, they should be guided by the logic of debt investment (vs. equity investment) and therefore be opposed to the expansion of shareholder value as a governing principle. Finally, using multilevel statistical models, it is demonstrated that by following the logic of debt investment, bond rating agencies ultimately discourage the SVO model of corporate governance via the corporate credit rating process. 2. Financialization and the emergence of SVO corporate practices The sociological literature studying the influence of finance on corporate governance tends to emphasize the rise of shareholder value as a ‘guiding principle’ (Carruthers and Kim, 2011). Scholars argue that this logic, fueled by influential social actors external to firms, has led to the emergence and increased isomorphism of corporate practices over the last half century including emphasis on de-diversification, returns for shareholders and investing in financial assets over physical assets. There has been a shift among US firms away from corporate conglomerates since the 1980s that has been attributed to hostile takeover firms, institutional investors and securities analysts (Fligstein, 2001; Dobbin and Zorn, 2005). Deregulation of merger restrictions in the Reagan era as well as the high levels of inflation from the 1970s created a profitable niche for hostile takeover firms. High inflation allowed hostile takeover firms to target companies whose physical assets totaled more than their market value incentivizing the divestment of assets (Davis, 2009). The rise of hostile takeover firms pressured CEOs to engage in de-diversification. Institutional investors were also linked to this shift in corporate logic and strategy. These influential investors subscribed to the commonly held belief that diversified firms had ‘artificially low’ stock prices and therefore promoted a return to ‘core-competencies’, which became formal business theory in 1990 (Prahalad and Hamel, 1990; Dobbin and Zorn, 2005, pp. 188, 190). Evidence from the 1980s and 1990s shows that the stock market rewarded firms that engaged in divestment with increased stock prices (Useem, 1996), and institutional investors continue to pressurize for de-diversification to boost stock prices in firms more recently (Jones and Nisbet, 2011; Widmer, 2011; Schwartz, 2014). Concurrently, securities analysts undermined the legitimacy of the multidivisional firm (Zuckerman, 2000). When assessing value in the stock market, securities analysts relied on an industry-based classification system. As they tried to make product comparisons in attempts to gauge the market position of conglomerates, assessments were complicated when a single firm would have products in multiple industries. By ignoring corporate conglomerates, which were denied ‘buy’ recommendations by securities analysts, they indirectly discouraged this corporate form (Zuckerman, 2000). The shift away from the ‘finance conception of control’, a logic of action that emphasized diversified corporate conglomerates founded on portfolio theory (Markowitz, 1952), led to the emergence of a ‘shareholder value conception of control’ that instead emphasized stock price maximization (Fligstein, 2001). Profits made by institutional investors largely come from stock portfolios. Therefore, it was in their interest to encourage firms to compensate executives with stock options and link bonuses to stock performance. Investors lobbied corporate boards to adopt stock-based incentives for management often citing agency theory which was popularized in the late 1970s (Jung and Dobbin, 2015). Financial analysts were also instrumental in the creation of the ‘shareholder value myth’ (Dobbin and Zorn, 2005). By publishing profit projections, even firms that were losing money could raise their stock prices by hitting analysts’ targets. Maximizing shareholder returns, as a goal for financial managers has become taken for granted in the world of corporate finance (Ho, 2009). Textbooks teaching corporate finance discuss the importance of enhancing shareholder returns and make it clear that financial managers should make this a priority above and beyond ‘maximizing profits’ (Davis, 2013, p. 7). The emergence of shareholder value norms is also attributed to the rise of financial managers who simultaneously encouraged the growth of financial profits in non-financial firms (NFCs) (Zorn, 2004; Krippner, 2011). Krippner (2005, p. 176) argues that the financialization of Corporate America, more than the shift to a service sector economy, is the ‘key development in the US economy in recent decades’. In an effort to resolve a crisis of resource distribution in the 1960s and 1970s, US policymakers, through key legislation, deregulated the financial industry. Concurrently, shareholder value norms became increasingly entrenched in corporate governance. Managers were not incentivized by firm expansion and accumulation, but instead by shareholder return and profit targets. These developments led to the adoption of ‘rentier-like’ (vs. ‘growth-oriented’) preferences by management, and ultimately to greater investment of profits in financial markets by NFCs (Stockhammer, 2004). Iconic American manufacturing and retail firms including General Electric, Sears, General Motors and Ford spun off their financial divisions that originally functioned as customer finance units into subsidiaries whose profits rivaled those of their parent firms (Davis, 2009; Krippner, 2011). As it became more and more popular for financial directors to sit on the boards of NFCs, profits from financing, production and sales became ‘integrated activities’ and NFCs increasingly began to ‘resemble financial corporations’ (Kirsch, 1997; Zorn, 2004; Krippner, 2005, pp. 201–202). Among NFCs, financial assets relative to sales rose from 24.4% in 1971 to 45.5% in 2011 (Davis, 2013). 3. The logics of corporate finance: equity vs. debt investment Though the emergence of an SVO among US corporate managers is well documented (Lazonick and O’Sullivan, 2000; Fligstein, 2001; Davis, 2005, 2009, 2013; Dobbin and Zorn, 2005; Ho, 2009; Dobbin and Jung, 2010; Gunnoe and Gellert, 2010; Carruthers and Kim, 2011; Tomaskovic-Devey and Lin, 2011; Lazonick, 2013; Van der Zwan, 2014; Jung and Dobbin, 2015), there has been some attention to alternative logics of corporate governance. Dating back to Freeman (1984), there have been theoretical discussions concerning stakeholder management as an alternative approach to achieving firm success. Stakeholder theory argues that corporate managers should attempt to satisfy all of a firm’s constituents rather than just its shareholders in order to maximize performance. There is a minority of firms that have embraced ‘broader social policies’ in order to satisfy the interests of all relevant firm constituents (vs. only shareholders) (Laplume etal., 2008, p. 1153). Out of this has emerged a ‘corporate social responsibility (CSR) movement’ in the USA that promotes long-term corporate goals tied to ‘social and environmental well-being’ (Williams and Conley, 2005, p. 495), and a similar philosophy dubbed ‘enlightened shareholder value’ in the UK (Ho, 2010). There has been debate in the business and management literature over the validity of the controversial stakeholder- based approaches (Hillman and Keim, 2001; Laplume etal., 2008; Jones and Nisbet, 2011). However, the non-financial behavioral sciences have ignored an alternative logic of corporate finance that contributes to corporate decision-making. According to economic theory, there are two sides of the capital investment coin, of which shareholder value only reflects the interests of one side. Those reflecting the interests of the other side stand in opposition to shareholder value maximization and have the potential to undermine SVO in corporate management, especially given the growth of debt financing in Corporate America. There is a taken for granted dichotomy that exists in economic theories of corporate finance that can potentially lead to conflicting logics of corporate behavior: debt financing vs. equity financing (Hillstrom, 2006). The decision-making of corporate managers is influenced by the type of financing they receive (Graham and Harvey, 2001; Jackson etal., 2013). This is due to the fact that different forms of financing create different investment vehicles (e.g. short- and long-term bonds are debt or credit investments while preferred and common stock are equity investments) and the holders of these different types of securities are largely assumed to have different objectives. Scholars of finance argue that the interests of debt investors (creditors and bondholders) and equity investors (shareholders) in a given firm can be at odds despite their aligned interest in the future success of the firm (Jensen and Meckling, 1976; Myers, 1977; Easterbrook, 1984; Schleifer and Vishny, 1997). Generally speaking, debt investors tend to be more risk averse than equity investors, which can create tension within a firm, as firm investment projects with high returns often come with high risk of failure (Ball, 2009). The difference in investor priorities is founded on basic differences in generally accepted investment strategies for financial securities. The process of bond selection used by debt investors has been referred to as a ‘negative art’ by securities analysts (Poitras, 2005, p. 344). The ‘upside potential’ of a bond issuer is of little concern to a debt investor relative to an equity investor. Debt investors are instead concerned with ‘downside risk’ (Langhor and Langhor, 2008, p. 84). Whereas equity investors are searching for a potential ‘big winner’, debt investors are focused almost exclusively on avoiding a potential ‘big loser’ (Poitras, 2005, p. 344). For this reason, debt investors are incentivized to be more cautious than equity investors. Leveraging moves can boost share prices (to the benefit of equity holders) while decreasing the cash flow necessary for interest coverage, ultimately hurting bond prices (to the detriment of debt holders). Unlike shareholders, bondholders prioritize regular revenues (over growth) to ensure interest payments can be made. Concern for downside risk by bondholders is apparent in the following example. Suppose the earnings of a long-term bond issuer are halved over some short- to mid-term time period (say from 40 times the firm’s bond interest coverage to only 20 times). The implications for equity losses are dramatic, whereas the credit risk of firm default remains low. The same relative drop in earnings for riskier issuers (say from twice the firm’s interest coverage to only once) will be taken much more seriously by debt investors. Interestingly, this demonstrates that the degree of alignment of interests for debt and equity investors is a function of a firm’s credit quality. Pioneers of option pricing theories promoted ideas that equity and debt investment are at odds. Black and Scholes (1973) demonstrated that while holding total firm value constant, increasing corporate debt in efforts to retire common stock should help stock prices while hurting bond prices. Merton (1974), and those that have expanded his work tying default risk to option pricing theory (Jones etal., 1984; Ritchken, 1987; Kim etal., 1993; Culp, 2001), showed that the value of a risky loan (or debt security) is equal to the value of a risk-free loan plus the value of a put option associated with default (Poitras, 2005, p. 345). This implies that buying a risky corporate bond is the same as buying a riskless government bond and shorting the put option on the firm’s assets. The upside is mathematically limited (Langhor and Langhor, 2008, p. 11). For equity investment however, the opposite is true, i.e. the upside is mathematically limitless. Equity investment is equivalent to buying call options on a firm’s assets. Shareholders reap all of the reward of a successful business. As a firm increases its business risk, option pricing theory tells us that the values of the put and the call increase. Because bondholders are short the put and stockholders are long the call, as riskiness increases, the stake of debt investors necessarily suffers at the expense of the stake of equity investors (Langhor and Langhor, 2008, p. 11). Given these economic theories of investment strategy, it is likely that there are conflicting logics in the field of corporate finance whereby the same corporate strategy (e.g. increasing a firm’s leverage) is taken for granted as rational and efficient by actors subscribing to what we might refer to as the ‘logic of equity investment’ and irrational and inefficient by those following the ‘logic of debt investment’. If option pricing theories accurately reflect the behavior of financial markets, then equity and debt holders should be competing for influence over the governance of the firms they are invested in, as these investors are driven by conflicting views about how the goals of corporate management should be achieved. Even if these popular theories are wrong, the fact that they have become taken for granted in the finance industry implies that conflicting views of governance practices by debt and equity investors is likely to be present in corporate finance. It should be clear that SVO, highlighted by those studying US corporate governance in recent decades, is a manifestation of the logic of equity investment. As discussed in the preceding section, management decisions to focus on core competencies, shareholder returns and financialized profits are moves to benefit the equity investments of shareholders. These are taken for granted strategies by those that have come to believe that the firm serves equity holders. However, economic theories of finance argue that firms also serve creditors and debt investors, whose interests and rationales are often in conflict with equity investors. As debt investment continues to increasingly dominate corporate financing (Sinclair, 2005; Schwarcz, 2017), the voice of those actors driving the logic of debt investment cannot be ignored by the non-financial behavioral sciences studying corporate governance in the USA. As discussed above, the economic and organizational sociology literature has mostly examined the ways in which influential actors like government entities, institutional investors, securities analysts and others have promoted an equity-oriented approach to corporate governance in the USA. Meanwhile, the economics literature has placed a much greater emphasis on examining the influence of debtholders on corporate governance. 4. Debt and corporate governance The economic research on corporate governance is largely based on agency theory, which attempts to resolve the potential problem caused by the separation of ownership and management: how can investors be sure that their funds are not wasted, and therefore, what approach to governance best aligns the interests of ownership and management? In Shleifer and Vishny’s (1997) influential survey of corporate governance, they note that the primary means of control over management employed by debtholders is via covenants. If a firm should violate a contractual obligation to a debtholder (such as missing an interest payment), control rights of the firm can be legally shifted to the debtholder who gains control of decision-making concerning firm assets. Debtholders have greater protections against loss than shareholders, but often have less day-to-day control over management unless a covenant has been directly violated. Like shareholder control, debtholder control is also a function of the size of the debtholder or concentration of the debt. Large creditors, such as banks, have the potential for significant control over firms, especially when involved in short-term lending. Above and beyond the covenants in place providing them with legal control in cases of violation, large creditors can directly control cash flow to firms giving them coercive power over management decisions (Shleifer and Vishny, 1997; Levine, 2004). Corporate governance research in economics has focused on a debate about national governance systems, often attempting to place nations on a spectrum from market-oriented systems (e.g. USA, UK) to bank-oriented ones (e.g. Germany, Japan) (Berglof, 1997; Becht and Roel, 1999; La Porta etal., 1999), though some have argued that the market- vs. bank-oriented system model is too simplistic (La Porta etal., 2000; Gutierrez and Surroca, 2014). Unfortunately, this has led many corporate governance studies to equate debtholders with banks. Given that there has been a dramatic shift toward disintermediation in the USA, where the relative importance of corporate bank loans as a source of financing has been falling since the 1970s (Sinclair, 2005), it should not be surprising that the finance literature also treats corporate governance in the USA as driven almost exclusively by the interests of equity. Meanwhile, corporate outstanding bond debt has been steadily growing and has more than quadrupled since 1995, approaching $9T in 2016 (SIFMA, 2017). More recently, studies have started examining the role that bondholders play in corporate governance. Bondholder activism, whereby bondholders enforce violations of covenants via restructuring or sending notices of default, is on the rise in the past two decades (Çelik etal., 2015). This has been attributed to increasing numbers of hedge funds, who attempt to capitalize on settlements (Kahan and Rock, 2009; Çelik etal., 2015), and may even be shoring up their bond holdings before directly engaging in enforcement of covenants to boost their profits (Gao etal., 2011, unpublished data). In contrast to hedge funds as aggressive bondholders, Çelik and Isaksson (2013) argue that the investment strategies of mutual funds, the other major type of large institutional bondholder, reflect long-term interests and result in low levels of engagement with corporate managers. Outside of banks and institutional bondholders (hedge funds, mutual funds), bond rating agencies are also influential actors in corporate finance that likely reflects the interests of debt investors. Yet, the impact of bond rating agencies on corporate governance has been largely overlooked even in the economics literature. While research has demonstrated that bond rating agencies indirectly wield power over large US corporations through the bond rating process, there has been little exploration of how they account for SVO and the associated corporate governance trends outlined in Section 2. 5. Bond rating agencies: influential actors discouraging SVO practices? Though corporate bond rating agencies claim that their ratings are merely ‘statements of opinion’ that should not be taken as recommendations for action (S&P, 2013), their ratings are real in their consequences, not only for investors, but for the bond issuers themselves. Because of this fact, scholars who study bond rating agencies claim that these entities have gained extensive power over capital flows in financial markets during the last half century (Kerwer, 2002; King and Sinclair, 2003; Thomas, 2004; Sinclair, 2005; Altman, 2010; Paudyn, 2013). At a minimum, ratings send signals to the market about the financial security of firms which is of great concern to management. Holthausen and Leftwich (1985) demonstrated that changes in bond rating directly influence an issuer’s stock price. Additionally, due to the changing environment of global capital finance, these bond rating agencies have become key gatekeepers to capital for corporate firms and government entities and thus influence the way these organizations conduct business. An increase in the importance of bond financing, and the incorporation of bond ratings into the regulatory laws of economically powerful nations, has contributed to the rise in power of bond rating agencies (King and Sinclair, 2003; Thomas, 2004; Sinclair, 2005; Carruthers, 2013; Schwarcz, 2017). Recent research has demonstrated that bond rating agencies have the power to influence organizational behaviors due to their unique position as gatekeepers to bond financing. When S&P downgraded New York State (NYS) bonds and cited ‘uncertainties’ associated with the state’s accounting practices as part of their justification for the downgrade, it not only impacted the price of the $12B in outstanding NYS bonds, but raised interest rates on future borrowing for the state. In response, the New York legislature immediately passed a bill adopting generally accepted accounting principles (GAAP), a popular form of financial reporting in the private sector, even though state legislators had been firmly opposed to adopting GAAP for almost a decade (Carpenter and Feroz, 1992). In the private sector, Graham and Harvey (2001) found that 57.1% of CFOs report that their corporate credit ratings are important or very important to their decisions regarding the amount of debt they allow their firm to take on. Kisgen (2006) demonstrated that firm decisions about capital structure (debt to net equity) are affected by rating concerns such that those firms that are on the border between major rating categories are less likely to issue new debt in efforts to induce upgrades or avoid downgrades. Kisgen (2009) also showed that downgrades by rating agencies, who often indicate that being overleveraged is a strike against firms, leads to a reduction in leverage by firms in the year following the downgrade. By releasing statements that publicly assess the creditworthiness of firms and municipalities, bond rating agencies are able to directly and indirectly signal to organizations about which specific practices they should and should not be employing if they hope to improve their credit ratings and increase the likelihood of bond financing. These agencies have the legitimacy and power to change the practices of corporations and appear to do so, intentionally or not. Recent research examining the behavior of bond rating agencies with regard to corporate governance decisions is not consistent when considering the logics of equity vs. debt investment. Attig etal. (2013) found that engaging in CSR leads to better ratings, thereby undermining the logic of equity investment. Ashbaugh-Skaife etal. (2006) found that bond rating agencies reward companies with weaker shareholder rights (as indicated by formal takeover defenses), which follows the logic of debt investment; however, they also found that these agencies reward board stock ownership, which appears to align with SVO. Louizi and Kammoun (2016) found that shareholder rights and management incentives are important factors when bond rating agencies build their corporate governance scores (measures of the strength of the governance of issuers), but that S&P does not directly factor these scores into their ratings while Moody’s does. Major bond rating agencies claim that as opinions, their ratings should not be used to ‘make any investment decisions’ (S&P, 2013). However, in practice, their product is a credit score used by bondholders to make investments, and therefore rating agencies should be implementing the logic of debt investment during the ratings process. This research seeks to demonstrate that major bond rating agencies (specifically, Moody’s and S&P), with their unique position in corporate finance that gives them the power to influence corporate governance, are guided by the logic of debt investment and therefore actively opposed to certain shareholder value oriented corporate practices. Given that the trends of management prioritization of core competencies, shareholder returns, and financialized profits are attributed to SVO, and that theories of financial economics argue that the logic of equity investment (which includes SVO) and debt investment are at odds, we might expect that bond rating agencies negatively sanction firms that engage in these behaviors with lower credit ratings. This finding would demonstrate that there are influential actors, external to firms, which are actively resisting the spread of shareholder value oriented management in U.S. corporate governance. Both Moody’s and S&P, the two largest bond rating agencies, produce publicly available documents that provide a peek at their ratings criteria in order to gain trust and legitimacy in the field. They do not provide the details, because they are profit seeking enterprises, and their ratings are their products. However, we can use these documents to gain some insight into the logic guiding the rating process. S&P makes it very clear that diversification is essential to earning a high credit rating. S&P argues that possessing multiple revenue streams from various business activities (e.g. separate product lines) reduces the risk of default if a subset of the revenue streams suffers (S&P, 1998, 2006, 2013). Therefore, increased diversity leads to a reduction in credit risk. Similarly, diversification is important to Moody’s credit assessment as well. Moody’s documents argue that diversification of ‘business lines and revenue streams’ can protect against shocks in specific markets caused by economic downturns, competition or government regulations, and therefore should be inversely associated with credit risk—‘having a diverse mix of products and end-markets, geographies and customers served enables a company to lessen its exposure to one product or one economy’ (Moody’s, 1998, 2012). This rationale, founded in the avoidance of long-term downside risk over upside potential, is aligned with the logic of debt investment. Similarly, the logic of debt investment rejects an emphasis by management to boost stock prices and pay dividends to shareholders (Easterbrook, 1984). Riskier ventures that can lead to higher expected shareholder returns are frowned upon by creditors who help bear the risk without added payoff (Poitras, 2005; Langhor and Langhor, 2008). This zero-sum game between shareholders and bondholders has become taken for granted by security analysts whose logic is founded in economic theory. Also, distributing profits to shareholders rather than reinvesting in the growth of the firm or building capital reserves for times of economic stress are viewed as risky behaviors by debt investors (Langhor and Langhor, 2008). Research links increasing firm emphasis on creating shareholder value to a decrease in the profit-to-investment1 1 Here investment refers to ‘real’ or ‘fixed’ or ‘physical’ investment and not financial investment. ratio among firms in the world’s leading economies (Stockhammer, 2005–2006). In other words, firms are reinvesting profits into physical materials and labor at increasingly lower rates than they have in the past. The potential short-sightedness of maximizing equity gains at the expense of future firm success by reducing physical investment aligns with the logic of equity investment and undermines the logic debt investment. Since the bursting of the tech bubble and the outbreak of corporate scandals (Enron, WorldCom, etc.) in the early 2000s, there has been plenty of evidence that stock prices do not necessarily reflect long-term firm performance. As Dobbin and Zorn (2005) argued, a corporate culture that emphasizes shareholder value incentivizes malfeasance (e.g. accounting fraud) and keeps management’s attention on financial figures for the upcoming quarter rather than on long-term firm survival. Some insight into how rating analysts view shareholder returns can be found in their publicly available ratings criteria documents. S&P is wary of short-term focused ownership that might push ‘financial policies aimed at achieving rapid returns for shareholders’ (S&P, 2013). Shareholder constraints on management are considered a potential ‘organizational problem’ (S&P, 1998). Moody’s reviews ‘financial incentives afforded to senior management, and specific associated targets (e.g. stock performance, EPS growth, profitability, de-leveraging)’ (Moody’s, 2010a). This statement confirms that management incentives, such as stock price, which leads to firm behavior oriented toward the maximization of shareholder returns, is factored into Moody’s rating decisions. In a different document, Moody’s makes it clear that they negatively view management ‘with a track record of favoring shareholder returns’ (Moody’s, 2013). Again, this rationale appears to follow the logic of debt (vs. equity) investment. Finally, those following the logic of debt investment may be wary of excess financial profits. Though these profits provide liquidity, which is valued by creditors (Moody’s, 2010b; S&P, 2010), too great of a reliance on financial markets, especially for NFCs can be viewed as market exposure that is a risk to long-term debt obligations. The growth in financial investments by NFCs reflects management’s ‘increasing propensity to short-termism’ that can lead to long-term uncertainty, and by extension, default risk (Orhangazi, 2008). Evidence indicates that as NFCs increasingly profit from finance, they decrease the amount spent on ‘fixed investment’ or ‘real investment’ (non-financial investment) (Orhangazi, 2008; Davis, 2013). Though it varies by industry, fixed investment is important for a firm’s long-term survival. For instance, S&P (2010) claims that in the global automaker industry, in order to maintain their creditworthiness, it is important that firms are ‘making what may be necessary new investments to remain competitive’. If automakers begin to prioritize financial securities at the expense of fixed investment (General Motors in the years leading up to their bankruptcy in 2009), this can indicate downside risk according to the logic of debt investment. Bond rating agencies are supposed to reduce moral hazard by identifying debt issuers that engage in risky behavior because of the limited liability associated with debt financing (Langhor and Langhor, 2008, p. 12). If bond rating agencies subscribe to the logic of debt investment, they should penalize rather than reward highly specialized firms that emphasize shareholder returns and make significant investments in financial markets. The statistical analysis that follows examines the degree to which these agencies have tended to support or discourage the aforementioned trends in corporate strategies before and after the financial crisis of 2008. Ordered probit regression models are used to predict corporate credit rating and determine whether emphasizing core competencies, shareholder returns and financial investments are rewarded or punished by these agencies via the rating process. 6. Data and methods 6.1 Bond ratings Credit ratings were measured using S&P and Moody’s corporate long-term issuer ratings.2 2 For Moody’s data, there were some firms in the sample without issuer ratings. For these firms, the corporate family rating (CFR) was used instead. A CFR is a long-term debt rating assigned to a ‘financial institution association or group, where the group may not exercise full management control, but where strong intragroup support and cohesion among individual group members may warrant a rating for the group or association’. It is almost always one alphanumeric category higher than an issuer rating (this was true in over 90% of the instances where both were present in the sample). Therefore, one ordinal value below the CFR (prior to rating aggregation) was used. This was performed for only 2.6% of firms in the FY2004 data and 11.2% of firms in the FY2011 data. This indicator was used by Cantor and Packer (1995, 1997) because it is available for all rated firms at the same point in time (unlike new bond issue ratings) and because it ignores the influences of bond types (e.g. debenture vs. asset backed, fixed rate vs. floating rate, etc.). It indicates the rating of a firm’s most representative long-term securities. The ratings from these two specific rating agencies were used as dependent variables based on the fact that they control most of the bond rating market. Moody’s and S&P accounted for more than three-quarters of all corporate bond ratings in 2010 (US Securities and Exchange Commission, 2011). Research predicting credit ratings using ordinal models typically collapse the total number of categories in order to increase the number of cases in each category (Ederington, 1986; Cantor and Packer, 1995, 1997; Blume etal., 1998). Thus, the 21-point ordinal rating scale was collapsed to four rating groups: less than BB, BB, BBB, greater than BBB (see Figure 1 for S&P ratings data). Ratings with modifiers were first collapsed into the general rating category before aggregation (e.g. BB− and BB+ were considered BB). This created an ordinal response with at least 245 observations per category in all models. These rating groups are analytically meaningful given that the qualitative distinction between speculative grade and investment grade bonds occurs at the transition from BB to BBB. The rating groups can therefore be conceptualized as ‘low speculative grade’ (<BB), ‘high speculative grade’ (BB), ‘low investment grade’ (BBB) and ‘high investment grade’ (>BBB). Figure 1. View largeDownload slide Distribution of S&P ratings data before and after aggregation. Figure 1. View largeDownload slide Distribution of S&P ratings data before and after aggregation. 6.2 Explanatory variables Indicators were constructed to measure firm emphasis on core competencies, shareholder value and financial investments. The specialization ratio (SR) was used as an indicator of firm emphasis on core competencies (Rumelt, 1982; Shaikh and Varadarajan, 1984; Pandya and Rao, 1998). The SR ‘reflects the importance of the firm’s core product market to that of the rest of the firm’ (Pandya and Rao, 1998, p. 70). It is measured as the firm’s annual revenues from its largest discrete product market activities (4-digit SIC) to its overall revenues. A low SR value indicates a highly diversified firm that profits from many different industries rather than solely focusing on the core competencies of the firm in one or a small number of industries. Therefore, a high SR value indicates a firm focusing on core competencies. Firm emphasis on shareholder returns was measured as total shareholder return (TSR):   TSR=(Pt-P0+Dt)P0 (1) where P0 is the firm’s stock price per share at some initial time, Pt is the firm’s stock price per share after some amount of time t has elapsed and Dt is the amount of dividends paid out per share by the firm during the elapsed time t (Institute of Management Accountants, 1997). The initial time chosen was 2 years before the fiscal year of the model. This provided enough time to wash out the noise of the stock market.3 3 As a check for robustness of the measure, TSR was also calculated using an initial time of 1 year prior to the fiscal year of the models and they yielded similar findings. Increasing stock prices and paying out large dividends (which is what TSR jointly measures) indicate which firms are emphasizing shareholder returns. However, these measures are confounded by other factors such as firm size and profitability, which are controlled for in the models. Any effects of TSR on firm credit ratings net of firm size and profitability are, therefore, assumed to reflect firm emphasis on shareholder returns. Total short-term investment (STI) was used as an indicator of firm emphasis on financial investments. STI is an accounting line that is required reporting for firms that measures total short-term financial assets such as stocks and bonds that can be ‘converted to cash within a relatively short period of time’, certificates of deposit, commercial paper, marketable securities, assets in money market funds, assets in real estate investment trusts and treasury bills (Xpressfeed Compustat Online Data Manual, 2014). Firms that are more heavily invested in securities of this type can be considered to be more financialized as they profit more from financial investment (vs. physical investment). Though this indicator is a direct measure of short-term financial investment by firms, it also influences the liquidity of firms which is an important predictor of credit ratings. The models control for liquidity in order to parse out any effect that emphasis on financial investment might have on ratings outside of the established positive impact that liquidity has on ratings. Additionally, increasing the amount of financial assets at a firm can reduce leverage, a measure of debt to assets. Therefore, the models control for leverage, another established indicator of credit rating. Rating agencies make it clear that highly leveraged firms might be less capable of repaying debts and are therefore riskier credit investments. 6.3 Control variables Controls were used to account for the proportion of rating variance explained by those financial accounting ratios known to be correlated with credit rating. Based on ratings criteria documents provided by Moody’s and S&P (Moody’s, 2012, 2013; S&P, 2013), along with previous studies that predict credit ratings (Ederington, 1986; Cantor and Packer, 1997; Blume etal., 1998), profitability, leverage, and liquidity were used as controls. The more profitable a company is, the less likely it should be to default on its loans. Profitability is measured as the ratio of net income to total assets (also known as return on assets). Leverage tells us how much debt a firm has in relation to its assets. Firms that are highly leveraged are more likely to default. Leverage is measured as long-term debt to assets. Interest coverage was used as a measure of liquidity. Interest coverage tells us whether or not a company is generating enough cash from its operations to meet the interest payments on its bonds. This variable is measured as the ratio of earnings before interest, taxes, depreciation, and amortization (EBITDA) to interest expenses. Firm size, measured as total assets (in millions USD), was also included in the model. The size of firms is indicated as being an important corporate credit risk factor in Moody’s and S&P ratings criteria documents (Moody’s, 2012, 2013; S&P, 2013). Also, the size of firms is often used as a covariate in economic models predicting credit ratings (Ederington, 1986; Blume etal., 1998; Pottier and Sommer, 1999; Morgan, 2002). Some studies do not find a significant effect from size net of other covariates, though it is often found that larger firms receive better ratings. This variable is hardly explored theoretically, but Blume etal. argue that larger firms ‘tend to be older, with more established product lines’ (1998, p. 1394) and therefore less likely to default. It is possible that larger firms are more visible and more likely to be legitimate actors. These firms might get the benefit of the doubt by a rating analyst when their final rating lands them on the border between two rating categories. Also, studies on the ‘liability of smallness’ (Hannan and Freeman, 1989; Barron etal., 1994) suggest that larger firms have the benefit of reducing their scale during periods of poor performance which may reduce their likelihood of failure. 6.4 Data and sample All firm financial data and S&P ratings came from the COMPUSTAT North American financials dataset, and all Moody’s ratings came from the Moody’s Inc. website. COMPUSTAT is a widely used source of public and private firm financial data boasting ‘more financial and industry-specific data items than any other data provider’ (S&P Capital IQ, 2014). Data were collected from fiscal years 2004 and 2011 to reflect S&P and Moody’s behavior since the Internet bubble crisis of the early 2000s, when public criticism of these agencies began to ramp up, ultimately leading to the US Credit Rating Agency Reform Act of 2006 (Langhor and Langhor, 2008). Evidence indicates that the divisions of major rating agencies that provided ratings for certain complex financial securities were faulty in the years leading up to 2008 (Taibbi, 2013). Not only did these agencies contribute to the misplaced confidence in the market, but they may have also been influenced by it. We included data from both before and after the credit crisis of 2008, to ensure that the findings were not influenced by the potential for misplaced confidence in markets pre-2008. The years that were chosen were relatively stable economic years with few corporate defaults and dynamic ratings. By 2004, the stock market had recovered to the pre-Internet-crash highs of the late 1990s, and by 2011, the stock market had almost completely recovered to pre-2008-crash levels. All firms that were rated at both time points were included in the regression models. Data was collected from time points 7 years apart because that is the median year to maturity for both Moody’s and S&P rated long-term corporate bonds (Jewell and Livingston, 1999). Firms tend to withdraw their ratings when they do not have any current bond issues. Therefore, firms that have ratings at both time points (7 years apart) are likely to regularly engage in bond financing, and are therefore the types of firms for which bond ratings are most salient. A sample of 719 firms rated by S&P during both years was used for the S&P models. A subset of this sample (657 firms), that included firms also rated by Moody’s during both years, was used for direct comparison of the two leading agencies. 6.5 Ordered probit multilevel regression models Because the dependent variable is ordinal and the latent risk function is assumed to be continuous, bond ratings were predicted with ordered probit regression models. The values for firm size, TSR and STI were logged to reduce positive skewness. Three-level ordered probit models were used with the first-level unit of analysis, occasions (firm-years), clustered within firms, clustered within sectors. The Global Industry Classification Standard (GICS) was used to cluster firms by the following nine sectors: (1) Energy, (2) Materials, (3) Industrials, (4) Consumer Discretionary, (5) Consumer Staples, (6) Health Care, (7) Financials, (8) Information Technology and Telecommunication Services and (9) Utilities4 4 The GICS treats Telecommunication Services and Utilities as separate sectors, but they were combined due to small cluster sizes. These sectors are often treated as similar, e.g. the Standard Industrial Classification (SIC) system combined utilities and communications into a single sector.. The ordered probit models can be conceptualized in terms of a latent response yijk* for occasion i in firm j in economic sector k such that:   yijk*=β1SRijk+β2TSRijk+β3STIijk+β4profijk+β5liqijk+β6levijk+β7sizeijk+ζjk(2)+ζk(3)+ϵijk (2) The ζjk(2) represent firm (second) level random intercepts, the ζk(3) represent sector (third) level random intercepts, and β1–β7 capture the effects of the fixed covariates, all of which are first-level variables. Because the response is ordinal, the above latent response equation translates into the following proportional odds model:   Pr (yijk>s|xijk)=Φβ1SRijk+…+β7sizeijk+ζjk(2)+ζk(3)-κs (3) where s∈{1, 2,…,S-1}, the xijk values represent the covariates ( SRijk,  TSRijk, etc.), Φ is the standard normal cumulative distribution function, and κs are category-specific parameters that act as thresholds subdividing the latent response scale. Because credit rating has been collapsed into four categories, S=4. 7. Results Table 1 shows the regression coefficients for the S&P models. The first three models predict S&P ratings using indicators for firm emphasis on core competencies, shareholder value and financial investments one at a time. The fourth model combines all three of these variables and there is not much change to the coefficients and standard errors. Models 5 through 8 add the control variables to each of the first four models. The final model (Model 9) includes significant second-order interaction terms. Table 1. Predicting S&P corporate bond ratings Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.69**  −0.80**      −0.83**  −0.86**  (0.30)      (0.29)  (0.25)      (0.24)  (0.24)  Shareholder ret.    −0.26**    −0.28**    −0.36**    −0.37**  −0.12    (0.07)    (0.07)    (0.07)    (0.07)  (0.09)  S-T investment      0.08**  0.08**      −0.06**  −0.05*  −0.25*      (0.02)  (0.02)      (0.02)  (0.02)  (0.12)  Profitability          8.50**  9.21**  8.33**  9.41**  12.02**          (0.94)  (0.94)  (0.95)  (0.95)  (1.15)  Leverage          −3.35**  −3.48**  −3.51**  −3.42**  −3.38**          (0.38)  (0.37)  (0.38)  (0.37)  (0.37)  Liquidity          0.53*  0.43†  0.53*  0.50*  1.11**          (0.22)  (0.22)  (0.22)  (0.22)  (0.37)  Firm size          0.74**  0.71**  0.81**  0.73**  0.66**          (0.05)  (0.05)  (0.06)  (0.06)  (0.06)  Share × Profit                  −3.50**                  (0.77)  Share × Liquidity                  −1.44*                  (0.59)  STI × Size                  0.02†    (0.01)    N  1265  1265  1265  1265  1265  1265  1265  1265  1265  Pseudo-R2  0.01  0.01  0.00  0.02  0.18  0.19  0.18  0.20  0.21  AIC  2938  2956  2960  2913  2433  2414  2437  2401  2365  BIC  2969  2986  2991  2955  2484  2465  2488  2462  2442  Wald chi-square  33.0**  14.7**  11.0**  62.7**  326.3**  349.1**  324.6**  353.4**  362.6**  Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.69**  −0.80**      −0.83**  −0.86**  (0.30)      (0.29)  (0.25)      (0.24)  (0.24)  Shareholder ret.    −0.26**    −0.28**    −0.36**    −0.37**  −0.12    (0.07)    (0.07)    (0.07)    (0.07)  (0.09)  S-T investment      0.08**  0.08**      −0.06**  −0.05*  −0.25*      (0.02)  (0.02)      (0.02)  (0.02)  (0.12)  Profitability          8.50**  9.21**  8.33**  9.41**  12.02**          (0.94)  (0.94)  (0.95)  (0.95)  (1.15)  Leverage          −3.35**  −3.48**  −3.51**  −3.42**  −3.38**          (0.38)  (0.37)  (0.38)  (0.37)  (0.37)  Liquidity          0.53*  0.43†  0.53*  0.50*  1.11**          (0.22)  (0.22)  (0.22)  (0.22)  (0.37)  Firm size          0.74**  0.71**  0.81**  0.73**  0.66**          (0.05)  (0.05)  (0.06)  (0.06)  (0.06)  Share × Profit                  −3.50**                  (0.77)  Share × Liquidity                  −1.44*                  (0.59)  STI × Size                  0.02†    (0.01)    N  1265  1265  1265  1265  1265  1265  1265  1265  1265  Pseudo-R2  0.01  0.01  0.00  0.02  0.18  0.19  0.18  0.20  0.21  AIC  2938  2956  2960  2913  2433  2414  2437  2401  2365  BIC  2969  2986  2991  2955  2484  2465  2488  2462  2442  Wald chi-square  33.0**  14.7**  11.0**  62.7**  326.3**  349.1**  324.6**  353.4**  362.6**  ** P < 0.01, * P  < 0.05, † P  < 0.10; two-tailed. In Models 5 through 9, we see that the control variables are all significant predictors of issuer ratings and in the expected directions. Profitability, liquidity and firm size have significant positive effects on S&P corporate credit ratings, while leverage has a significant negative effect. The coefficient for specialization, an indicator of firm emphasis on core competencies, is negative and significant in all of the models where it is present, though the effect size is reduced once the control variables are introduced. The coefficient for shareholder return, an indicator of firm emphasis on shareholder value, is also negative and significant, but the effect size grows once the controls are added. Finally, STI, an indicator of firm emphasis on financial investments, is positive and significant in the models without controls, and negative and significant in the models with controls. The coefficients for the variables reflecting firm emphasis on core competencies, shareholder value and financial investments are all significant and negative in the full first-order model (Model 8). This suggests that rating analysts view engaging in these practices as independently detrimental to firms in the long term. Firms with high SRs, that therefore earn most of their profits from a single or limited number of industries, are less likely to receive higher credit ratings from Standard & Poor’s net of covariates. S&P discourages emphasis on shareholder value as well. Those firms with higher levels of shareholder return in the 2 years prior to their rating are less likely to receive higher ratings net of their size and level of profitability. Finally, those firms with a greater amount of short-term financial assets are less likely to receive higher ratings net of the liquidity that those assets provide. The changes in the three explanatory variables across the models in Table 1 are logically consistent. Firm size and specialization have a significant negative correlation (r = −0.21), which should not be surprising considering that multidivisional firms tend to be larger in size. When firm size is introduced into the model, the negative effect of specialization is reduced because the influence on ratings due to its correlation with smaller firms is parsed out. Similarly, shareholder return is significantly correlated with profitability (r = 0.17). Profitable firms are more likely to pay dividends and have increasing stock prices. Therefore, the negative effect of shareholder return on credit ratings is suppressed in Models 2 and 4 because profitability has a positive impact on ratings. When profitability is added to the model, the negative effect of shareholder return grows because the suppressor has been removed. Finally, STI is significantly correlated with liquidity (r = 0.18). Stocks, money market funds, short-term bonds and other similar financial assets are very easy to cash in. In Models 3 and 4, the interaction between these two variables causes STI to appear to be positively correlated with ratings. However, once liquidity is controlled for, the true relationship between financial investments and ratings becomes clear. Financial assets outside of the liquidity that they bring to a firm are frowned upon by S&P. Model 9 introduces statistically significant second-order interaction effects. For more profitable firms with higher levels of liquidity, the effect of emphasizing shareholder return on credit rating becomes more negative (i.e. the magnitude of the negative relationship between shareholder return and credit rating grows). This finding tells us that the ‘better’ a firm is doing in the financial sense (i.e. more liquid and profitable), the more that S&P negatively assesses emphasizing shareholder return. There is also a weak interaction between STI and firm size as well. Though excessive financial profits are punished with lower ratings, the effect is attenuated for larger firms. The parallel-regressions assumption is violated for firm size and STI. This implies that the relationship between these variables and credit rating is nonlinear, as the regression coefficients for these variables differ across each threshold (i.e. these variables affect the probability of being in a higher rating category differently depending on the rating category). Firm size is always a positive significant predictor of rating regardless of the threshold (α < 0.01). The influence of STI decreases with increasing threshold and ultimately is no longer a significant predictor of rating across the low- to high-investment grade threshold. This tells us that though financialization is generally a significant predictor of credit rating, it is not important for differentiating between highly rated firms. When we compare the Moody’s models in Table 2 to the S&P models in Table 1, we see that the agencies are very consistent in their treatment of the model variables when generating ratings. All of the coefficients in the Moody’s models are significant and in the same direction as the S&P models except for when we introduce second-order interactions. Table 2. Predicting Moody’s corporate bond ratings Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.62**  −0.80**      −0.82**  −4.09*  (0.34)      (0.33)  (0.29)      (0.28)  (1.73)  Shareholder ret.    −0.40**    −0.39**    −0.52**    −0.51**  −0.30**    (0.10)    (0.10)    (0.11)    (0.11)  (0.11)  S-T investment      0.09**  0.09**      −0.07**  −0.07**  −0.07**      (0.03)  (0.03)      (0.03)  (0.02)  (0.02)  Profitability          7.60**  8.93**  7.54**  9.11**  12.01**          (1.09)  (1.13)  (1.11)  (1.14)  (1.33)  Leverage          −3.63**  −3.85**  −3.90**  −3.79**  −3.86**          (0.50)  (0.49)  (0.50)  (0.49)  (0.49)  Liquidity          2.98**  2.66**  2.97**  2.77**  2.46**          (0.53)  (0.52)  (0.52)  (0.51)  (0.51)  Firm size          0.89**  0.87**  0.99**  0.89**  0.64**          (0.07)  (0.06)  (0.07)  (0.07)  (0.15)  Spec. × Size                  −0.37†                  (0.20)  Share × Profit                  −3.92**                  (1.07)    N  1150  1150  1150  1150  1150  1150  1150  1150  1150  Pseudo-R2  0.01  0.01  0.00  0.02  0.21  0.22  0.21  0.22  0.23  AIC  2643  2649  2656  2618  2115  2096  2114  2083  2061  BIC  2673  2680  2686  2658  2166  2146  2165  2144  2134  Wald chi-square  24.7**  14.5**  11.3**  53.5**  289.7**  306.3**  287.9**  314.5**  316.3**  Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.62**  −0.80**      −0.82**  −4.09*  (0.34)      (0.33)  (0.29)      (0.28)  (1.73)  Shareholder ret.    −0.40**    −0.39**    −0.52**    −0.51**  −0.30**    (0.10)    (0.10)    (0.11)    (0.11)  (0.11)  S-T investment      0.09**  0.09**      −0.07**  −0.07**  −0.07**      (0.03)  (0.03)      (0.03)  (0.02)  (0.02)  Profitability          7.60**  8.93**  7.54**  9.11**  12.01**          (1.09)  (1.13)  (1.11)  (1.14)  (1.33)  Leverage          −3.63**  −3.85**  −3.90**  −3.79**  −3.86**          (0.50)  (0.49)  (0.50)  (0.49)  (0.49)  Liquidity          2.98**  2.66**  2.97**  2.77**  2.46**          (0.53)  (0.52)  (0.52)  (0.51)  (0.51)  Firm size          0.89**  0.87**  0.99**  0.89**  0.64**          (0.07)  (0.06)  (0.07)  (0.07)  (0.15)  Spec. × Size                  −0.37†                  (0.20)  Share × Profit                  −3.92**                  (1.07)    N  1150  1150  1150  1150  1150  1150  1150  1150  1150  Pseudo-R2  0.01  0.01  0.00  0.02  0.21  0.22  0.21  0.22  0.23  AIC  2643  2649  2656  2618  2115  2096  2114  2083  2061  BIC  2673  2680  2686  2658  2166  2146  2165  2144  2134  Wald chi-square  24.7**  14.5**  11.3**  53.5**  289.7**  306.3**  287.9**  314.5**  316.3**  ** P < 0.01, * P < 0.05, † P < 0.10; two-tailed. Only two of the second-order interaction terms are significant in the Moody’s model. Just like in the S&P model, the negative effect of shareholder return on credit rating is stronger for more profitable firms. Unlike the S&P model, there is a negative interaction between specialization and size. This means that though rating agencies punish all firms that emphasize core competencies, they punish larger firms more harshly for doing so. Also, like the S&P models, the parallel-regressions assumption was violated for firm size and short-term investment yielding identical nonlinear behavior. 8. Discussion Sociological scholars have focused on documenting and explaining the isomorphic spread of shareholder value as a guiding logic in US corporate firms. As discussed in the second section above, the emergence of shareholder value oriented management has led to the proliferation of specific corporate practices that serve the interests of equity investors. But recent literature emphasizing the institutional logics approach to understanding organizational behavior has been critical of research centered on isomorphism (Thornton and Ocasio 2008). It has argued that ‘new institutional’ approaches obscure heterogeneity of key constructs such as efficiency, rationality and participation in organizational fields while simultaneously treating these concepts as neutral and deterministic. There are often conflicting institutional logics in a given organizational field, market or industry. The existence of conflicting logics in the inter-institutional system allows for contradiction and change to existing dominant logics in an organizational field (Thornton and Ocasio, 2008). Dominant logics are frequently supplanted by subsidiary or conflicting ones as their legitimacy becomes contested (Thornton and Ocasio, 1999; Kitchener, 2002; Lounsbury, 2002, 2007; Zajac and Westphal, 2004; Greenwood and Suddaby, 2006). For example, Scott etal. (2000) and Reay and Hinings (2005) found that a single dominant institutional logic in the healthcare field transitioned into three unique logics that coexist in a relatively stable fashion. This paper draws on the finance literature to demonstrate that there is not a single, consistent market logic (Thornton and Ocasio, 1999, 2008) permeating corporate finance, but instead the conflicting market logics of debt and equity investment. The shareholder value approach is a manifestation of the broader logic of equity investment. This logic of how a firm should function only reflects the interests of a certain set of investors, and according to leading theories of corporate finance, is often opposed to another logic guiding the values and behaviors of debt investment. The field of corporate finance is multi-dimensional (Graham and Smart, 2012) and the logics of these dimensions are not necessarily aligned. Rational means of leveraged financing (e.g. issue bonds and take on a lot of debt) are at odds with downside risk management5 5 The term ‘downside risk management’ is used here instead of the more generic term ‘risk management’ to avoid potential confusion that might be caused by Power’s (2005a,b, 2009) work on ‘enterprise risk management’ (ERM), which he argues is an emerging risk based conception of corporate control. ERM is a practice of corporate internal risk management that attempts to control risks threatening ‘company value’. This new conception of control, which rose to prominence in conjunction with the legitimacy of Credit Risk Officers, is argued to be an instantiation of the corporate logic of shareholder value and therefore follows the logic of equity investment. (e.g. reduce exposure by eliminating debt). Bond rating agencies, being more concerned with firm survival over growth, rely more heavily on the logic of debt investment. Through the above examination of qualitative and quantitative data from the two largest bond rating agencies, it is clear that for more than a decade, bond rating agencies, powerful actors in corporate finance that have been demonstrated to influence issuer behavior, discourage practices linked to shareholder value and the logic of equity investment. This is due to the fact that they serve the interests of debt investors and are therefore guided by a logic that leading financial theories argue is at odds with shareholder value and equity investment. Both major bond rating agencies, Moody’s and Standard and Poor’s, discourage firm specialization and strict emphasis on core competencies. They provide significantly lower ratings to those firms that focus on generating profits in a single or few industries. Moody’s and S&P also punish firms that emphasize shareholder returns. The above models find that the more firms produce short-term increases in share price and dividend payouts to shareholders independently of profits and firm size, the less likely they are to receive higher ratings. Finally, both major bond rating agencies have been negatively sanctioning financial investments beyond the added liquidity that they provide. The above models find that those firms with more short-term financial investments are less likely to receive higher ratings once we control for liquidity. This implies that rating agencies are concerned with excess STI. According to the models above, the major bond raters believe that short-term financial investments are a detriment to long-term firm health outside of their potential to generate cash flow. This research suggests that what is deemed economically rational in the world of corporate finance is inconsistent between types of social actors. The adoption of three specific strategies by corporate executives that are believed to be rational, efficient means for growth and future firm success—emphasizing core competencies, shareholder returns and financialized profits—are consistent with the logic of equity investment. In contrast, major bond rating agencies are drawing on the logic of debt investment which views the very same practices to be detrimental to future firm health. Given that organizational scholars have become increasingly wary of the progressive dominance of shareholder value oriented management, these findings highlight an important question. To what degree does resistance to the logic of equity investment exist in the field of corporate finance? It has been documented that the rights of debt investors have been expanding via changing corporate reorganization laws in the USA providing more control for creditors (Skeel, 2003). But this added control for debt investors comes after a firm has already gotten itself into serious financial trouble, potentially by following the logic of equity investment. The dominance of bond financing as the primary form of corporate financing in the USA might generate a stronger mechanism for resisting shareholder value in corporate governance. As bond financing continues to grow, and the bond market continues to increasingly trade at higher relative rates than equity (Schwarcz, 2017), it is logical that the sanctions by bond rating agencies which undermine SVO practices will become increasingly important to understanding corporate governance in the USA. However, despite resistance from major rating agencies in the form of lower ratings, organizational scholars continue to observe convergence toward many SVO behaviors by firms rather than away from them. It is likely that corporate managers, who have been demonstrated to account for corporate ratings in their decision making, have a hierarchy of governance strategies that they rely on when making decisions based on competing incentives. They are constantly trying to manage contradictory rationalizations in order to please different social actors; specifically those endorsing the logic of equity investment vs. debt investment. The push and pull felt from a range of organizations in the field of corporate finance (e.g. institutional investors, shareholders, board members, regulators, securities analysts, etc.) guide decision-making within the corporate organization and lead to the adoption or avoidance of different behaviors. Though their firm’s bond rating is important to managers, satisfying their board, institutional investors, or even their own pocketbooks may take greater priority. If corporate governing boards, under the influence of institutional investors, tie financial incentivizes to shareholder value, then corporate managers may be willing to take the hit to their corporate credit rating for boosting shareholder returns if it leads to a larger pay bonus in the short term. Though downside risk management is a concern, it might not be as much of a priority for corporate managers as other dimensions of corporate finance. This explanation is consistent with claims made by Ocasio (1997) who argues that institutions structure the attention of social actors embedded within them. Institutional logics focus the attention of decision makers (e.g. corporate managers) by providing a set of interests and identities as well as a guide to the ‘importance, and relevance of issues and solutions’ (Thornton and Ocasio, 2008). Conflicting logics in a given field create competing interests and issues that need resolution. Corporate managers, given their unique social position, can identify and exploit differences in corporate finance logics to advance the interests that they’ve internalized as priorities (often their own) (Fligstein, 1987; Battilana, 2006). They understand the importance of firm leverage and liquidity to their credit rating, but also understand the importance of meeting analyst expectations in order to boost stock prices. They juggle and strategically employ contradictory logics (such as the logics of equity and debt investment) in order to meet the competing demands being placed upon them. This article demonstrates that future sociological research on corporate governance in the USA needs to recognize the potential resistance to shareholder value oriented management by powerful agents reflecting the interests of debtholders. There are multiple avenues this research might take. First, the degree to which the one logic dominates the other is in need of exploration. Current research on US corporate governance seems to have concluded that the logic of equity investment has come to dominate corporate management. Is the logic of equity investment continuing to spread despite resistance from external actors in corporate finance representing the interests of debt investment (bond rating agencies, hedge funds), or is the logic of debt investment gaining a stronger foothold in recent years given the increased importance of bond vs. equity issuance in corporate finance? Second, future research needs to examine the extent to which corporate managers are juggling these competing demands. Past research shows that managers are sensitive to their firm’s credit ratings. Why then has there been a continued emphasis on de-diversification, shareholder returns, and financialized profits despite the negative sanctions being levied by rating agencies? Is it due to a hierarchy of priorities whereby debtholder concerns are given lower priority? Or instead, is it possible that rating agencies are not clear in signaling which behaviors are discouraged by debtholders? Third, we need a further understanding of how these logics interact. Are debtholders and equity holders always in direct competition? Theories of finance suggest that the alignment of these competing interests varies by the financial health of the firm they are invested in such that there will be more alignment between debt and equity interests in financially riskier firms with poor financial health. Our statistical models show inconsistent findings. For both Moody’s and S&P, the more profitable a firm, the more punishment there is for emphasizing shareholder returns. S&P also penalizes highly liquid firms more for shareholder returns. Our findings imply that the stronger the firm’s financial position (via high profitability, and in the case of S&P, high liquidity as well), the greater the disdain for equity driven shareholder returns. In other words, there is greater divergence of equity and debt interests for firms with stronger financial health, as theories of finance would predict. However, we also find that in both the Moody’s and S&P models, the effect of STI (net of liquidity) is nonlinear and only a significant predictor for differentiating high risk companies. This implies that financialized profits are not a concern of bond rating agencies for financially healthy firms. Therefore, debt and equity interests are only at odds over the equity-driven practice of financialized profits for firms with weaker financial positions contrary to expectations from theories of finance. These findings suggest that the relationship between the logics of equity and debt investment is not necessarily as straightforward as theories of finance would suggest. Further investigation should identify under which situations these logics are at odds, and when they might instead be aligned, potentially producing constructive interference and mutually reinforcing specific behaviors. Under conditions of alignment of debt and equity investment logics, we would expect isomorphic trends. Finally, sociological scholars have spent much time and energy evaluating the ‘shareholder value myth’. Drawing on Meyer and Rowan’s (1977) theory of institutional myths, it has been argued that the corporate governance model committed to the maximization of shareholder value is not necessarily superior to older models of governance, despite its popularity (Dobbin and Zorn, 2005). This implies that the logic of equity investment is not necessarily a rational guide to firm success. Isn’t it also possible that the logic of debt investment possesses myth-like qualities? For example, it might be the case that diversification is not always beneficial to the long-term success of firms, as major bond rating agencies appear to believe. It is apparent from this research, that the behavior of bond rating agencies is consistent with the logic of debt investment founded in financial economic theories. But these theories might not be consistently accurate reflections of empirical reality. Is it possible that rating agencies are guided by flawed logic? Further research needs to evaluate the degree to which rating decisions reflecting the logic of debt investment reliably predict firm default. Major bond rating agencies have been implicated in contributing to the collapse of the housing market by knowingly engaging in unlawful behavior while rating mortgaged-backed securities (Taibbi, 2013). This led to S&P’s recent settlement with the Justice Department for $1.38B, the largest penalty ever paid by a rating agency (Davidson etal., 2015). However, it is possible that outside of the documented malfeasance of ‘bad actors’ in the rating industry, major rating agencies might be promoting institutional myths about which practices are optimal for generating long-term firm success. Further investigation is warranted. 9. Conclusion This research contributes to the sociological literature on finance and corporate governance. It argues that the shareholder value oriented management model in US corporate firms is a manifestation of a broader logic based in financial economic theory; that of equity investment. Additionally, there exists a logic of debt investment that competes for the attention of corporate managers. The logic of debt investment has been largely ignored by the non-financial behavioral sciences. This article demonstrates that influential social actors in the field of corporate finance subscribe to this logic of debt investment, and it calls for additional examination of the influence of debt investment on US corporate governance, especially given the increased dominance of debt financing among US corporate firms. At a time when debt financing is more important than ever, we need to understand how the SVO model will begin to recede, or alternatively, explain why it continues to flourish despite opposition from an increasingly influential set of actors. Additionally, this paper hopes to call greater attention to the role that bond rating agencies play in corporate governance. Though there have been a few limited studies examining rating agencies and corporate governance (Ashbaugh-Skaife etal., 2006; Attig etal., 2013; Louizi and Kammoun, 2016), they fail to locate the motives of these agencies in a broader logic based in theories of financial economics, and are therefore limited in their explanatory power. Further, most of the economic research examining the influence of debt investment on corporate governance focuses on banks and debtholders. Given their potential for influencing corporate management (see Section 5 above), and the evidence from this paper demonstrating that these actors have been negatively sanctioning SVO corporate strategies, additional examination of how bond rating agencies influence US corporate governance and the spread of shareholder value oriented strategies is necessary. This research also contributes to the institutional logics literature. It is clear that corporate finance is a field in which there are multiple logics operating simultaneously, demonstrating the complexity of the market logic that guides the rationale of corporate firms. We can think of these conflicting logics as complementary social forces that provide balance for firms. The logic of equity investment seems to push for relatively risky endeavors that might lead to innovation and growth. The logic of debt investment pushes against risk, and emphasizes stability. Corporate managers are simultaneously guided by these opposing logics and ideally generate a balance for their firms between short-term growth and long-term stability. Finally, these findings have important implications for the financial industry as well. If embracing SVO practices is detrimental to long-term firm survival as many critics suggest, then the negative sanctions provided by bond rating agencies are good for the financial system as a whole (in terms of stability). However, it appears that corporate managers continue to employ these practices despite the demonstrated negative impact on rating. This implies that the balance between these conflicting logics of corporate finance has been tipped in the favor of equity investment as the interests of corporate executives and even fund managers become aligned with shareholders (Widmer, 2011; Jung and Dobbin, 2015). Future research should examine how corporate managers decide when to respond to the pressures placed on them by rating agencies, as well as what potential collaborative arrangements are used to reconcile the conflicting logics (Reay and Hinings, 2005). The extent to which specialization, shareholder returns and financial profits are detrimental to long-term firm success should also be explored. The shareholder value myth has become central to the rationale of financial actors following the logic of equity investment. 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( 2004) ‘The Social Construction of Market Value: Institutionalization and Learning Perspectives on Stock Market Reactions’, American Sociological Review , 69, 433– 458. Google Scholar CrossRef Search ADS   Zorn D. M. ( 2004) ‘ Here a Chief, There a Chief: The Rise of the CFO in the American Firm’, American Sociological Review , 69, 345– 364. Google Scholar CrossRef Search ADS   Zuckerman E. W. ( 2000) ‘ Focusing the Corporate Product: Securities Analysts and De-Diversification’, Administrative Science Quarterly , 45, 591– 619. Google Scholar CrossRef Search ADS   © The Author 2017. Published by Oxford University Press and the Society for the Advancement of Socio-Economics. All rights reserved. For Permissions, please email: journals.permissions@oup.com http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Socio-Economic Review Oxford University Press

Opposition to shareholder value: bond rating agencies and conflicting logics in corporate finance

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Oxford University Press
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© The Author 2017. Published by Oxford University Press and the Society for the Advancement of Socio-Economics. All rights reserved. For Permissions, please email: journals.permissions@oup.com
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1475-1461
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1475-147X
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10.1093/ser/mwx041
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Abstract

Abstract Research examining the financialization of American firms has largely concentrated on the rise in the shareholder value orientation (SVO) among corporate managers and the subsequent adoption of specific corporate strategies. However, this article argues that in theories of finance, the SVO is a manifestation of only one of the logic models followed by investors—that of equity investment. Equally important, according to these theories, is the logic of debt investment which is often at odds with the logic of equity investment. This article demonstrates that overlooked influential actors in the field of corporate finance that subscribe to this logic of debt investment, i.e. bond rating agencies, are actively discouraging the spread of shareholder value-driven corporate practices via the bond rating process. This is important given the shift to bond financing as the primary form of corporate finance in the USA. 1. Introduction Economic and organizational sociologists have placed a major emphasis on studying the influence of the financial industry on the evolution of the American corporate firm during the last half century. However, the literature examining the intersection of financialization and corporate governance in the USA has almost exclusively focused on the growth of the shareholder value conception of control (Lazonick and O’Sullivan, 2000; Fligstein, 2001; Davis, 2005, 2009, 2013; Dobbin and Zorn, 2005; Ho, 2009; Dobbin and Jung, 2010; Gunnoe and Gellert, 2010; Carruthers and Kim, 2011; Tomaskovic-Devey and Lin, 2011; Lazonick, 2013; Van der Zwan, 2014; Jung and Dobbin, 2015). Though there has been some empirical examination of the spread and contestation of a shareholder value orientation (SVO) within coordinated market economies (Rose and Mejer, 2003; Fiss and Zajac, 2004; 2006; Sanders and Tuschke, 2007; Yoshikawa etal., 2007; Bezemer etal., 2015), there has been little examination of resistance to this dominant logic in US corporate finance. This article demonstrates that there are indeed powerful social actors in the field of corporate finance that actively discourage the spread of SVO practices in US corporate governance. Economic theories of corporate finance have long argued that the interests of equity investors and debt investors are not necessarily aligned and can often be at odds. Yet, the sociological and organizational literature has continued to largely focus on the influence of SVO policies in corporate governance which reflect the interests of equity investment over debt investment. Despite the decline in corporate bank loans in the USA since the 1970s, there has been a dramatic rise in corporate debt financing via bond issues to the point where bonds have become the dominant form of corporate financing (Sinclair, 2005; Schwarcz, 2017). As debt financing increasingly continues to drive corporate growth in the USA, the power of bond rating agencies, which represent the interests of debt investors, has increased. Drawing on economic theories from finance, this article argues that the SVO approach to corporate governance only reflects one-half of the investment logic driving corporate financing despite its centering in sociological research on financialization. Further, it empirically demonstrates that there are influential financial actors who openly resist isomorphic SVO-driven corporate practices studied in the sociological literature. Bond rating agencies, which possess coercive power over firms and ultimately reflect the interests of debt holders, negatively sanction firms that engage in popular SVO practices. Given the shifting ratio of debt to equity financing, this research demonstrates the need for an expanded inquiry into the logics driving corporate governance in order to achieve a more complete picture of how financialization is shaping the US corporate landscape. This article begins by reviewing the literature from economic sociology that documents the expansion of financialization and shareholder value oriented practices in US corporate governance. It goes on to locate the SVO model in a specific logic of corporate finance which we refer to as the ‘logic of equity investment’, and highlights the conflicting ‘logic of debt investment’, which has been mostly overlooked outside of the finance literature and stands counter to shareholder value oriented management. The article then emphasizes the importance of bond rating agencies as powerful social actors, who influence corporate governance. It is argued that given their position in the field of corporate finance, they should be guided by the logic of debt investment (vs. equity investment) and therefore be opposed to the expansion of shareholder value as a governing principle. Finally, using multilevel statistical models, it is demonstrated that by following the logic of debt investment, bond rating agencies ultimately discourage the SVO model of corporate governance via the corporate credit rating process. 2. Financialization and the emergence of SVO corporate practices The sociological literature studying the influence of finance on corporate governance tends to emphasize the rise of shareholder value as a ‘guiding principle’ (Carruthers and Kim, 2011). Scholars argue that this logic, fueled by influential social actors external to firms, has led to the emergence and increased isomorphism of corporate practices over the last half century including emphasis on de-diversification, returns for shareholders and investing in financial assets over physical assets. There has been a shift among US firms away from corporate conglomerates since the 1980s that has been attributed to hostile takeover firms, institutional investors and securities analysts (Fligstein, 2001; Dobbin and Zorn, 2005). Deregulation of merger restrictions in the Reagan era as well as the high levels of inflation from the 1970s created a profitable niche for hostile takeover firms. High inflation allowed hostile takeover firms to target companies whose physical assets totaled more than their market value incentivizing the divestment of assets (Davis, 2009). The rise of hostile takeover firms pressured CEOs to engage in de-diversification. Institutional investors were also linked to this shift in corporate logic and strategy. These influential investors subscribed to the commonly held belief that diversified firms had ‘artificially low’ stock prices and therefore promoted a return to ‘core-competencies’, which became formal business theory in 1990 (Prahalad and Hamel, 1990; Dobbin and Zorn, 2005, pp. 188, 190). Evidence from the 1980s and 1990s shows that the stock market rewarded firms that engaged in divestment with increased stock prices (Useem, 1996), and institutional investors continue to pressurize for de-diversification to boost stock prices in firms more recently (Jones and Nisbet, 2011; Widmer, 2011; Schwartz, 2014). Concurrently, securities analysts undermined the legitimacy of the multidivisional firm (Zuckerman, 2000). When assessing value in the stock market, securities analysts relied on an industry-based classification system. As they tried to make product comparisons in attempts to gauge the market position of conglomerates, assessments were complicated when a single firm would have products in multiple industries. By ignoring corporate conglomerates, which were denied ‘buy’ recommendations by securities analysts, they indirectly discouraged this corporate form (Zuckerman, 2000). The shift away from the ‘finance conception of control’, a logic of action that emphasized diversified corporate conglomerates founded on portfolio theory (Markowitz, 1952), led to the emergence of a ‘shareholder value conception of control’ that instead emphasized stock price maximization (Fligstein, 2001). Profits made by institutional investors largely come from stock portfolios. Therefore, it was in their interest to encourage firms to compensate executives with stock options and link bonuses to stock performance. Investors lobbied corporate boards to adopt stock-based incentives for management often citing agency theory which was popularized in the late 1970s (Jung and Dobbin, 2015). Financial analysts were also instrumental in the creation of the ‘shareholder value myth’ (Dobbin and Zorn, 2005). By publishing profit projections, even firms that were losing money could raise their stock prices by hitting analysts’ targets. Maximizing shareholder returns, as a goal for financial managers has become taken for granted in the world of corporate finance (Ho, 2009). Textbooks teaching corporate finance discuss the importance of enhancing shareholder returns and make it clear that financial managers should make this a priority above and beyond ‘maximizing profits’ (Davis, 2013, p. 7). The emergence of shareholder value norms is also attributed to the rise of financial managers who simultaneously encouraged the growth of financial profits in non-financial firms (NFCs) (Zorn, 2004; Krippner, 2011). Krippner (2005, p. 176) argues that the financialization of Corporate America, more than the shift to a service sector economy, is the ‘key development in the US economy in recent decades’. In an effort to resolve a crisis of resource distribution in the 1960s and 1970s, US policymakers, through key legislation, deregulated the financial industry. Concurrently, shareholder value norms became increasingly entrenched in corporate governance. Managers were not incentivized by firm expansion and accumulation, but instead by shareholder return and profit targets. These developments led to the adoption of ‘rentier-like’ (vs. ‘growth-oriented’) preferences by management, and ultimately to greater investment of profits in financial markets by NFCs (Stockhammer, 2004). Iconic American manufacturing and retail firms including General Electric, Sears, General Motors and Ford spun off their financial divisions that originally functioned as customer finance units into subsidiaries whose profits rivaled those of their parent firms (Davis, 2009; Krippner, 2011). As it became more and more popular for financial directors to sit on the boards of NFCs, profits from financing, production and sales became ‘integrated activities’ and NFCs increasingly began to ‘resemble financial corporations’ (Kirsch, 1997; Zorn, 2004; Krippner, 2005, pp. 201–202). Among NFCs, financial assets relative to sales rose from 24.4% in 1971 to 45.5% in 2011 (Davis, 2013). 3. The logics of corporate finance: equity vs. debt investment Though the emergence of an SVO among US corporate managers is well documented (Lazonick and O’Sullivan, 2000; Fligstein, 2001; Davis, 2005, 2009, 2013; Dobbin and Zorn, 2005; Ho, 2009; Dobbin and Jung, 2010; Gunnoe and Gellert, 2010; Carruthers and Kim, 2011; Tomaskovic-Devey and Lin, 2011; Lazonick, 2013; Van der Zwan, 2014; Jung and Dobbin, 2015), there has been some attention to alternative logics of corporate governance. Dating back to Freeman (1984), there have been theoretical discussions concerning stakeholder management as an alternative approach to achieving firm success. Stakeholder theory argues that corporate managers should attempt to satisfy all of a firm’s constituents rather than just its shareholders in order to maximize performance. There is a minority of firms that have embraced ‘broader social policies’ in order to satisfy the interests of all relevant firm constituents (vs. only shareholders) (Laplume etal., 2008, p. 1153). Out of this has emerged a ‘corporate social responsibility (CSR) movement’ in the USA that promotes long-term corporate goals tied to ‘social and environmental well-being’ (Williams and Conley, 2005, p. 495), and a similar philosophy dubbed ‘enlightened shareholder value’ in the UK (Ho, 2010). There has been debate in the business and management literature over the validity of the controversial stakeholder- based approaches (Hillman and Keim, 2001; Laplume etal., 2008; Jones and Nisbet, 2011). However, the non-financial behavioral sciences have ignored an alternative logic of corporate finance that contributes to corporate decision-making. According to economic theory, there are two sides of the capital investment coin, of which shareholder value only reflects the interests of one side. Those reflecting the interests of the other side stand in opposition to shareholder value maximization and have the potential to undermine SVO in corporate management, especially given the growth of debt financing in Corporate America. There is a taken for granted dichotomy that exists in economic theories of corporate finance that can potentially lead to conflicting logics of corporate behavior: debt financing vs. equity financing (Hillstrom, 2006). The decision-making of corporate managers is influenced by the type of financing they receive (Graham and Harvey, 2001; Jackson etal., 2013). This is due to the fact that different forms of financing create different investment vehicles (e.g. short- and long-term bonds are debt or credit investments while preferred and common stock are equity investments) and the holders of these different types of securities are largely assumed to have different objectives. Scholars of finance argue that the interests of debt investors (creditors and bondholders) and equity investors (shareholders) in a given firm can be at odds despite their aligned interest in the future success of the firm (Jensen and Meckling, 1976; Myers, 1977; Easterbrook, 1984; Schleifer and Vishny, 1997). Generally speaking, debt investors tend to be more risk averse than equity investors, which can create tension within a firm, as firm investment projects with high returns often come with high risk of failure (Ball, 2009). The difference in investor priorities is founded on basic differences in generally accepted investment strategies for financial securities. The process of bond selection used by debt investors has been referred to as a ‘negative art’ by securities analysts (Poitras, 2005, p. 344). The ‘upside potential’ of a bond issuer is of little concern to a debt investor relative to an equity investor. Debt investors are instead concerned with ‘downside risk’ (Langhor and Langhor, 2008, p. 84). Whereas equity investors are searching for a potential ‘big winner’, debt investors are focused almost exclusively on avoiding a potential ‘big loser’ (Poitras, 2005, p. 344). For this reason, debt investors are incentivized to be more cautious than equity investors. Leveraging moves can boost share prices (to the benefit of equity holders) while decreasing the cash flow necessary for interest coverage, ultimately hurting bond prices (to the detriment of debt holders). Unlike shareholders, bondholders prioritize regular revenues (over growth) to ensure interest payments can be made. Concern for downside risk by bondholders is apparent in the following example. Suppose the earnings of a long-term bond issuer are halved over some short- to mid-term time period (say from 40 times the firm’s bond interest coverage to only 20 times). The implications for equity losses are dramatic, whereas the credit risk of firm default remains low. The same relative drop in earnings for riskier issuers (say from twice the firm’s interest coverage to only once) will be taken much more seriously by debt investors. Interestingly, this demonstrates that the degree of alignment of interests for debt and equity investors is a function of a firm’s credit quality. Pioneers of option pricing theories promoted ideas that equity and debt investment are at odds. Black and Scholes (1973) demonstrated that while holding total firm value constant, increasing corporate debt in efforts to retire common stock should help stock prices while hurting bond prices. Merton (1974), and those that have expanded his work tying default risk to option pricing theory (Jones etal., 1984; Ritchken, 1987; Kim etal., 1993; Culp, 2001), showed that the value of a risky loan (or debt security) is equal to the value of a risk-free loan plus the value of a put option associated with default (Poitras, 2005, p. 345). This implies that buying a risky corporate bond is the same as buying a riskless government bond and shorting the put option on the firm’s assets. The upside is mathematically limited (Langhor and Langhor, 2008, p. 11). For equity investment however, the opposite is true, i.e. the upside is mathematically limitless. Equity investment is equivalent to buying call options on a firm’s assets. Shareholders reap all of the reward of a successful business. As a firm increases its business risk, option pricing theory tells us that the values of the put and the call increase. Because bondholders are short the put and stockholders are long the call, as riskiness increases, the stake of debt investors necessarily suffers at the expense of the stake of equity investors (Langhor and Langhor, 2008, p. 11). Given these economic theories of investment strategy, it is likely that there are conflicting logics in the field of corporate finance whereby the same corporate strategy (e.g. increasing a firm’s leverage) is taken for granted as rational and efficient by actors subscribing to what we might refer to as the ‘logic of equity investment’ and irrational and inefficient by those following the ‘logic of debt investment’. If option pricing theories accurately reflect the behavior of financial markets, then equity and debt holders should be competing for influence over the governance of the firms they are invested in, as these investors are driven by conflicting views about how the goals of corporate management should be achieved. Even if these popular theories are wrong, the fact that they have become taken for granted in the finance industry implies that conflicting views of governance practices by debt and equity investors is likely to be present in corporate finance. It should be clear that SVO, highlighted by those studying US corporate governance in recent decades, is a manifestation of the logic of equity investment. As discussed in the preceding section, management decisions to focus on core competencies, shareholder returns and financialized profits are moves to benefit the equity investments of shareholders. These are taken for granted strategies by those that have come to believe that the firm serves equity holders. However, economic theories of finance argue that firms also serve creditors and debt investors, whose interests and rationales are often in conflict with equity investors. As debt investment continues to increasingly dominate corporate financing (Sinclair, 2005; Schwarcz, 2017), the voice of those actors driving the logic of debt investment cannot be ignored by the non-financial behavioral sciences studying corporate governance in the USA. As discussed above, the economic and organizational sociology literature has mostly examined the ways in which influential actors like government entities, institutional investors, securities analysts and others have promoted an equity-oriented approach to corporate governance in the USA. Meanwhile, the economics literature has placed a much greater emphasis on examining the influence of debtholders on corporate governance. 4. Debt and corporate governance The economic research on corporate governance is largely based on agency theory, which attempts to resolve the potential problem caused by the separation of ownership and management: how can investors be sure that their funds are not wasted, and therefore, what approach to governance best aligns the interests of ownership and management? In Shleifer and Vishny’s (1997) influential survey of corporate governance, they note that the primary means of control over management employed by debtholders is via covenants. If a firm should violate a contractual obligation to a debtholder (such as missing an interest payment), control rights of the firm can be legally shifted to the debtholder who gains control of decision-making concerning firm assets. Debtholders have greater protections against loss than shareholders, but often have less day-to-day control over management unless a covenant has been directly violated. Like shareholder control, debtholder control is also a function of the size of the debtholder or concentration of the debt. Large creditors, such as banks, have the potential for significant control over firms, especially when involved in short-term lending. Above and beyond the covenants in place providing them with legal control in cases of violation, large creditors can directly control cash flow to firms giving them coercive power over management decisions (Shleifer and Vishny, 1997; Levine, 2004). Corporate governance research in economics has focused on a debate about national governance systems, often attempting to place nations on a spectrum from market-oriented systems (e.g. USA, UK) to bank-oriented ones (e.g. Germany, Japan) (Berglof, 1997; Becht and Roel, 1999; La Porta etal., 1999), though some have argued that the market- vs. bank-oriented system model is too simplistic (La Porta etal., 2000; Gutierrez and Surroca, 2014). Unfortunately, this has led many corporate governance studies to equate debtholders with banks. Given that there has been a dramatic shift toward disintermediation in the USA, where the relative importance of corporate bank loans as a source of financing has been falling since the 1970s (Sinclair, 2005), it should not be surprising that the finance literature also treats corporate governance in the USA as driven almost exclusively by the interests of equity. Meanwhile, corporate outstanding bond debt has been steadily growing and has more than quadrupled since 1995, approaching $9T in 2016 (SIFMA, 2017). More recently, studies have started examining the role that bondholders play in corporate governance. Bondholder activism, whereby bondholders enforce violations of covenants via restructuring or sending notices of default, is on the rise in the past two decades (Çelik etal., 2015). This has been attributed to increasing numbers of hedge funds, who attempt to capitalize on settlements (Kahan and Rock, 2009; Çelik etal., 2015), and may even be shoring up their bond holdings before directly engaging in enforcement of covenants to boost their profits (Gao etal., 2011, unpublished data). In contrast to hedge funds as aggressive bondholders, Çelik and Isaksson (2013) argue that the investment strategies of mutual funds, the other major type of large institutional bondholder, reflect long-term interests and result in low levels of engagement with corporate managers. Outside of banks and institutional bondholders (hedge funds, mutual funds), bond rating agencies are also influential actors in corporate finance that likely reflects the interests of debt investors. Yet, the impact of bond rating agencies on corporate governance has been largely overlooked even in the economics literature. While research has demonstrated that bond rating agencies indirectly wield power over large US corporations through the bond rating process, there has been little exploration of how they account for SVO and the associated corporate governance trends outlined in Section 2. 5. Bond rating agencies: influential actors discouraging SVO practices? Though corporate bond rating agencies claim that their ratings are merely ‘statements of opinion’ that should not be taken as recommendations for action (S&P, 2013), their ratings are real in their consequences, not only for investors, but for the bond issuers themselves. Because of this fact, scholars who study bond rating agencies claim that these entities have gained extensive power over capital flows in financial markets during the last half century (Kerwer, 2002; King and Sinclair, 2003; Thomas, 2004; Sinclair, 2005; Altman, 2010; Paudyn, 2013). At a minimum, ratings send signals to the market about the financial security of firms which is of great concern to management. Holthausen and Leftwich (1985) demonstrated that changes in bond rating directly influence an issuer’s stock price. Additionally, due to the changing environment of global capital finance, these bond rating agencies have become key gatekeepers to capital for corporate firms and government entities and thus influence the way these organizations conduct business. An increase in the importance of bond financing, and the incorporation of bond ratings into the regulatory laws of economically powerful nations, has contributed to the rise in power of bond rating agencies (King and Sinclair, 2003; Thomas, 2004; Sinclair, 2005; Carruthers, 2013; Schwarcz, 2017). Recent research has demonstrated that bond rating agencies have the power to influence organizational behaviors due to their unique position as gatekeepers to bond financing. When S&P downgraded New York State (NYS) bonds and cited ‘uncertainties’ associated with the state’s accounting practices as part of their justification for the downgrade, it not only impacted the price of the $12B in outstanding NYS bonds, but raised interest rates on future borrowing for the state. In response, the New York legislature immediately passed a bill adopting generally accepted accounting principles (GAAP), a popular form of financial reporting in the private sector, even though state legislators had been firmly opposed to adopting GAAP for almost a decade (Carpenter and Feroz, 1992). In the private sector, Graham and Harvey (2001) found that 57.1% of CFOs report that their corporate credit ratings are important or very important to their decisions regarding the amount of debt they allow their firm to take on. Kisgen (2006) demonstrated that firm decisions about capital structure (debt to net equity) are affected by rating concerns such that those firms that are on the border between major rating categories are less likely to issue new debt in efforts to induce upgrades or avoid downgrades. Kisgen (2009) also showed that downgrades by rating agencies, who often indicate that being overleveraged is a strike against firms, leads to a reduction in leverage by firms in the year following the downgrade. By releasing statements that publicly assess the creditworthiness of firms and municipalities, bond rating agencies are able to directly and indirectly signal to organizations about which specific practices they should and should not be employing if they hope to improve their credit ratings and increase the likelihood of bond financing. These agencies have the legitimacy and power to change the practices of corporations and appear to do so, intentionally or not. Recent research examining the behavior of bond rating agencies with regard to corporate governance decisions is not consistent when considering the logics of equity vs. debt investment. Attig etal. (2013) found that engaging in CSR leads to better ratings, thereby undermining the logic of equity investment. Ashbaugh-Skaife etal. (2006) found that bond rating agencies reward companies with weaker shareholder rights (as indicated by formal takeover defenses), which follows the logic of debt investment; however, they also found that these agencies reward board stock ownership, which appears to align with SVO. Louizi and Kammoun (2016) found that shareholder rights and management incentives are important factors when bond rating agencies build their corporate governance scores (measures of the strength of the governance of issuers), but that S&P does not directly factor these scores into their ratings while Moody’s does. Major bond rating agencies claim that as opinions, their ratings should not be used to ‘make any investment decisions’ (S&P, 2013). However, in practice, their product is a credit score used by bondholders to make investments, and therefore rating agencies should be implementing the logic of debt investment during the ratings process. This research seeks to demonstrate that major bond rating agencies (specifically, Moody’s and S&P), with their unique position in corporate finance that gives them the power to influence corporate governance, are guided by the logic of debt investment and therefore actively opposed to certain shareholder value oriented corporate practices. Given that the trends of management prioritization of core competencies, shareholder returns, and financialized profits are attributed to SVO, and that theories of financial economics argue that the logic of equity investment (which includes SVO) and debt investment are at odds, we might expect that bond rating agencies negatively sanction firms that engage in these behaviors with lower credit ratings. This finding would demonstrate that there are influential actors, external to firms, which are actively resisting the spread of shareholder value oriented management in U.S. corporate governance. Both Moody’s and S&P, the two largest bond rating agencies, produce publicly available documents that provide a peek at their ratings criteria in order to gain trust and legitimacy in the field. They do not provide the details, because they are profit seeking enterprises, and their ratings are their products. However, we can use these documents to gain some insight into the logic guiding the rating process. S&P makes it very clear that diversification is essential to earning a high credit rating. S&P argues that possessing multiple revenue streams from various business activities (e.g. separate product lines) reduces the risk of default if a subset of the revenue streams suffers (S&P, 1998, 2006, 2013). Therefore, increased diversity leads to a reduction in credit risk. Similarly, diversification is important to Moody’s credit assessment as well. Moody’s documents argue that diversification of ‘business lines and revenue streams’ can protect against shocks in specific markets caused by economic downturns, competition or government regulations, and therefore should be inversely associated with credit risk—‘having a diverse mix of products and end-markets, geographies and customers served enables a company to lessen its exposure to one product or one economy’ (Moody’s, 1998, 2012). This rationale, founded in the avoidance of long-term downside risk over upside potential, is aligned with the logic of debt investment. Similarly, the logic of debt investment rejects an emphasis by management to boost stock prices and pay dividends to shareholders (Easterbrook, 1984). Riskier ventures that can lead to higher expected shareholder returns are frowned upon by creditors who help bear the risk without added payoff (Poitras, 2005; Langhor and Langhor, 2008). This zero-sum game between shareholders and bondholders has become taken for granted by security analysts whose logic is founded in economic theory. Also, distributing profits to shareholders rather than reinvesting in the growth of the firm or building capital reserves for times of economic stress are viewed as risky behaviors by debt investors (Langhor and Langhor, 2008). Research links increasing firm emphasis on creating shareholder value to a decrease in the profit-to-investment1 1 Here investment refers to ‘real’ or ‘fixed’ or ‘physical’ investment and not financial investment. ratio among firms in the world’s leading economies (Stockhammer, 2005–2006). In other words, firms are reinvesting profits into physical materials and labor at increasingly lower rates than they have in the past. The potential short-sightedness of maximizing equity gains at the expense of future firm success by reducing physical investment aligns with the logic of equity investment and undermines the logic debt investment. Since the bursting of the tech bubble and the outbreak of corporate scandals (Enron, WorldCom, etc.) in the early 2000s, there has been plenty of evidence that stock prices do not necessarily reflect long-term firm performance. As Dobbin and Zorn (2005) argued, a corporate culture that emphasizes shareholder value incentivizes malfeasance (e.g. accounting fraud) and keeps management’s attention on financial figures for the upcoming quarter rather than on long-term firm survival. Some insight into how rating analysts view shareholder returns can be found in their publicly available ratings criteria documents. S&P is wary of short-term focused ownership that might push ‘financial policies aimed at achieving rapid returns for shareholders’ (S&P, 2013). Shareholder constraints on management are considered a potential ‘organizational problem’ (S&P, 1998). Moody’s reviews ‘financial incentives afforded to senior management, and specific associated targets (e.g. stock performance, EPS growth, profitability, de-leveraging)’ (Moody’s, 2010a). This statement confirms that management incentives, such as stock price, which leads to firm behavior oriented toward the maximization of shareholder returns, is factored into Moody’s rating decisions. In a different document, Moody’s makes it clear that they negatively view management ‘with a track record of favoring shareholder returns’ (Moody’s, 2013). Again, this rationale appears to follow the logic of debt (vs. equity) investment. Finally, those following the logic of debt investment may be wary of excess financial profits. Though these profits provide liquidity, which is valued by creditors (Moody’s, 2010b; S&P, 2010), too great of a reliance on financial markets, especially for NFCs can be viewed as market exposure that is a risk to long-term debt obligations. The growth in financial investments by NFCs reflects management’s ‘increasing propensity to short-termism’ that can lead to long-term uncertainty, and by extension, default risk (Orhangazi, 2008). Evidence indicates that as NFCs increasingly profit from finance, they decrease the amount spent on ‘fixed investment’ or ‘real investment’ (non-financial investment) (Orhangazi, 2008; Davis, 2013). Though it varies by industry, fixed investment is important for a firm’s long-term survival. For instance, S&P (2010) claims that in the global automaker industry, in order to maintain their creditworthiness, it is important that firms are ‘making what may be necessary new investments to remain competitive’. If automakers begin to prioritize financial securities at the expense of fixed investment (General Motors in the years leading up to their bankruptcy in 2009), this can indicate downside risk according to the logic of debt investment. Bond rating agencies are supposed to reduce moral hazard by identifying debt issuers that engage in risky behavior because of the limited liability associated with debt financing (Langhor and Langhor, 2008, p. 12). If bond rating agencies subscribe to the logic of debt investment, they should penalize rather than reward highly specialized firms that emphasize shareholder returns and make significant investments in financial markets. The statistical analysis that follows examines the degree to which these agencies have tended to support or discourage the aforementioned trends in corporate strategies before and after the financial crisis of 2008. Ordered probit regression models are used to predict corporate credit rating and determine whether emphasizing core competencies, shareholder returns and financial investments are rewarded or punished by these agencies via the rating process. 6. Data and methods 6.1 Bond ratings Credit ratings were measured using S&P and Moody’s corporate long-term issuer ratings.2 2 For Moody’s data, there were some firms in the sample without issuer ratings. For these firms, the corporate family rating (CFR) was used instead. A CFR is a long-term debt rating assigned to a ‘financial institution association or group, where the group may not exercise full management control, but where strong intragroup support and cohesion among individual group members may warrant a rating for the group or association’. It is almost always one alphanumeric category higher than an issuer rating (this was true in over 90% of the instances where both were present in the sample). Therefore, one ordinal value below the CFR (prior to rating aggregation) was used. This was performed for only 2.6% of firms in the FY2004 data and 11.2% of firms in the FY2011 data. This indicator was used by Cantor and Packer (1995, 1997) because it is available for all rated firms at the same point in time (unlike new bond issue ratings) and because it ignores the influences of bond types (e.g. debenture vs. asset backed, fixed rate vs. floating rate, etc.). It indicates the rating of a firm’s most representative long-term securities. The ratings from these two specific rating agencies were used as dependent variables based on the fact that they control most of the bond rating market. Moody’s and S&P accounted for more than three-quarters of all corporate bond ratings in 2010 (US Securities and Exchange Commission, 2011). Research predicting credit ratings using ordinal models typically collapse the total number of categories in order to increase the number of cases in each category (Ederington, 1986; Cantor and Packer, 1995, 1997; Blume etal., 1998). Thus, the 21-point ordinal rating scale was collapsed to four rating groups: less than BB, BB, BBB, greater than BBB (see Figure 1 for S&P ratings data). Ratings with modifiers were first collapsed into the general rating category before aggregation (e.g. BB− and BB+ were considered BB). This created an ordinal response with at least 245 observations per category in all models. These rating groups are analytically meaningful given that the qualitative distinction between speculative grade and investment grade bonds occurs at the transition from BB to BBB. The rating groups can therefore be conceptualized as ‘low speculative grade’ (<BB), ‘high speculative grade’ (BB), ‘low investment grade’ (BBB) and ‘high investment grade’ (>BBB). Figure 1. View largeDownload slide Distribution of S&P ratings data before and after aggregation. Figure 1. View largeDownload slide Distribution of S&P ratings data before and after aggregation. 6.2 Explanatory variables Indicators were constructed to measure firm emphasis on core competencies, shareholder value and financial investments. The specialization ratio (SR) was used as an indicator of firm emphasis on core competencies (Rumelt, 1982; Shaikh and Varadarajan, 1984; Pandya and Rao, 1998). The SR ‘reflects the importance of the firm’s core product market to that of the rest of the firm’ (Pandya and Rao, 1998, p. 70). It is measured as the firm’s annual revenues from its largest discrete product market activities (4-digit SIC) to its overall revenues. A low SR value indicates a highly diversified firm that profits from many different industries rather than solely focusing on the core competencies of the firm in one or a small number of industries. Therefore, a high SR value indicates a firm focusing on core competencies. Firm emphasis on shareholder returns was measured as total shareholder return (TSR):   TSR=(Pt-P0+Dt)P0 (1) where P0 is the firm’s stock price per share at some initial time, Pt is the firm’s stock price per share after some amount of time t has elapsed and Dt is the amount of dividends paid out per share by the firm during the elapsed time t (Institute of Management Accountants, 1997). The initial time chosen was 2 years before the fiscal year of the model. This provided enough time to wash out the noise of the stock market.3 3 As a check for robustness of the measure, TSR was also calculated using an initial time of 1 year prior to the fiscal year of the models and they yielded similar findings. Increasing stock prices and paying out large dividends (which is what TSR jointly measures) indicate which firms are emphasizing shareholder returns. However, these measures are confounded by other factors such as firm size and profitability, which are controlled for in the models. Any effects of TSR on firm credit ratings net of firm size and profitability are, therefore, assumed to reflect firm emphasis on shareholder returns. Total short-term investment (STI) was used as an indicator of firm emphasis on financial investments. STI is an accounting line that is required reporting for firms that measures total short-term financial assets such as stocks and bonds that can be ‘converted to cash within a relatively short period of time’, certificates of deposit, commercial paper, marketable securities, assets in money market funds, assets in real estate investment trusts and treasury bills (Xpressfeed Compustat Online Data Manual, 2014). Firms that are more heavily invested in securities of this type can be considered to be more financialized as they profit more from financial investment (vs. physical investment). Though this indicator is a direct measure of short-term financial investment by firms, it also influences the liquidity of firms which is an important predictor of credit ratings. The models control for liquidity in order to parse out any effect that emphasis on financial investment might have on ratings outside of the established positive impact that liquidity has on ratings. Additionally, increasing the amount of financial assets at a firm can reduce leverage, a measure of debt to assets. Therefore, the models control for leverage, another established indicator of credit rating. Rating agencies make it clear that highly leveraged firms might be less capable of repaying debts and are therefore riskier credit investments. 6.3 Control variables Controls were used to account for the proportion of rating variance explained by those financial accounting ratios known to be correlated with credit rating. Based on ratings criteria documents provided by Moody’s and S&P (Moody’s, 2012, 2013; S&P, 2013), along with previous studies that predict credit ratings (Ederington, 1986; Cantor and Packer, 1997; Blume etal., 1998), profitability, leverage, and liquidity were used as controls. The more profitable a company is, the less likely it should be to default on its loans. Profitability is measured as the ratio of net income to total assets (also known as return on assets). Leverage tells us how much debt a firm has in relation to its assets. Firms that are highly leveraged are more likely to default. Leverage is measured as long-term debt to assets. Interest coverage was used as a measure of liquidity. Interest coverage tells us whether or not a company is generating enough cash from its operations to meet the interest payments on its bonds. This variable is measured as the ratio of earnings before interest, taxes, depreciation, and amortization (EBITDA) to interest expenses. Firm size, measured as total assets (in millions USD), was also included in the model. The size of firms is indicated as being an important corporate credit risk factor in Moody’s and S&P ratings criteria documents (Moody’s, 2012, 2013; S&P, 2013). Also, the size of firms is often used as a covariate in economic models predicting credit ratings (Ederington, 1986; Blume etal., 1998; Pottier and Sommer, 1999; Morgan, 2002). Some studies do not find a significant effect from size net of other covariates, though it is often found that larger firms receive better ratings. This variable is hardly explored theoretically, but Blume etal. argue that larger firms ‘tend to be older, with more established product lines’ (1998, p. 1394) and therefore less likely to default. It is possible that larger firms are more visible and more likely to be legitimate actors. These firms might get the benefit of the doubt by a rating analyst when their final rating lands them on the border between two rating categories. Also, studies on the ‘liability of smallness’ (Hannan and Freeman, 1989; Barron etal., 1994) suggest that larger firms have the benefit of reducing their scale during periods of poor performance which may reduce their likelihood of failure. 6.4 Data and sample All firm financial data and S&P ratings came from the COMPUSTAT North American financials dataset, and all Moody’s ratings came from the Moody’s Inc. website. COMPUSTAT is a widely used source of public and private firm financial data boasting ‘more financial and industry-specific data items than any other data provider’ (S&P Capital IQ, 2014). Data were collected from fiscal years 2004 and 2011 to reflect S&P and Moody’s behavior since the Internet bubble crisis of the early 2000s, when public criticism of these agencies began to ramp up, ultimately leading to the US Credit Rating Agency Reform Act of 2006 (Langhor and Langhor, 2008). Evidence indicates that the divisions of major rating agencies that provided ratings for certain complex financial securities were faulty in the years leading up to 2008 (Taibbi, 2013). Not only did these agencies contribute to the misplaced confidence in the market, but they may have also been influenced by it. We included data from both before and after the credit crisis of 2008, to ensure that the findings were not influenced by the potential for misplaced confidence in markets pre-2008. The years that were chosen were relatively stable economic years with few corporate defaults and dynamic ratings. By 2004, the stock market had recovered to the pre-Internet-crash highs of the late 1990s, and by 2011, the stock market had almost completely recovered to pre-2008-crash levels. All firms that were rated at both time points were included in the regression models. Data was collected from time points 7 years apart because that is the median year to maturity for both Moody’s and S&P rated long-term corporate bonds (Jewell and Livingston, 1999). Firms tend to withdraw their ratings when they do not have any current bond issues. Therefore, firms that have ratings at both time points (7 years apart) are likely to regularly engage in bond financing, and are therefore the types of firms for which bond ratings are most salient. A sample of 719 firms rated by S&P during both years was used for the S&P models. A subset of this sample (657 firms), that included firms also rated by Moody’s during both years, was used for direct comparison of the two leading agencies. 6.5 Ordered probit multilevel regression models Because the dependent variable is ordinal and the latent risk function is assumed to be continuous, bond ratings were predicted with ordered probit regression models. The values for firm size, TSR and STI were logged to reduce positive skewness. Three-level ordered probit models were used with the first-level unit of analysis, occasions (firm-years), clustered within firms, clustered within sectors. The Global Industry Classification Standard (GICS) was used to cluster firms by the following nine sectors: (1) Energy, (2) Materials, (3) Industrials, (4) Consumer Discretionary, (5) Consumer Staples, (6) Health Care, (7) Financials, (8) Information Technology and Telecommunication Services and (9) Utilities4 4 The GICS treats Telecommunication Services and Utilities as separate sectors, but they were combined due to small cluster sizes. These sectors are often treated as similar, e.g. the Standard Industrial Classification (SIC) system combined utilities and communications into a single sector.. The ordered probit models can be conceptualized in terms of a latent response yijk* for occasion i in firm j in economic sector k such that:   yijk*=β1SRijk+β2TSRijk+β3STIijk+β4profijk+β5liqijk+β6levijk+β7sizeijk+ζjk(2)+ζk(3)+ϵijk (2) The ζjk(2) represent firm (second) level random intercepts, the ζk(3) represent sector (third) level random intercepts, and β1–β7 capture the effects of the fixed covariates, all of which are first-level variables. Because the response is ordinal, the above latent response equation translates into the following proportional odds model:   Pr (yijk>s|xijk)=Φβ1SRijk+…+β7sizeijk+ζjk(2)+ζk(3)-κs (3) where s∈{1, 2,…,S-1}, the xijk values represent the covariates ( SRijk,  TSRijk, etc.), Φ is the standard normal cumulative distribution function, and κs are category-specific parameters that act as thresholds subdividing the latent response scale. Because credit rating has been collapsed into four categories, S=4. 7. Results Table 1 shows the regression coefficients for the S&P models. The first three models predict S&P ratings using indicators for firm emphasis on core competencies, shareholder value and financial investments one at a time. The fourth model combines all three of these variables and there is not much change to the coefficients and standard errors. Models 5 through 8 add the control variables to each of the first four models. The final model (Model 9) includes significant second-order interaction terms. Table 1. Predicting S&P corporate bond ratings Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.69**  −0.80**      −0.83**  −0.86**  (0.30)      (0.29)  (0.25)      (0.24)  (0.24)  Shareholder ret.    −0.26**    −0.28**    −0.36**    −0.37**  −0.12    (0.07)    (0.07)    (0.07)    (0.07)  (0.09)  S-T investment      0.08**  0.08**      −0.06**  −0.05*  −0.25*      (0.02)  (0.02)      (0.02)  (0.02)  (0.12)  Profitability          8.50**  9.21**  8.33**  9.41**  12.02**          (0.94)  (0.94)  (0.95)  (0.95)  (1.15)  Leverage          −3.35**  −3.48**  −3.51**  −3.42**  −3.38**          (0.38)  (0.37)  (0.38)  (0.37)  (0.37)  Liquidity          0.53*  0.43†  0.53*  0.50*  1.11**          (0.22)  (0.22)  (0.22)  (0.22)  (0.37)  Firm size          0.74**  0.71**  0.81**  0.73**  0.66**          (0.05)  (0.05)  (0.06)  (0.06)  (0.06)  Share × Profit                  −3.50**                  (0.77)  Share × Liquidity                  −1.44*                  (0.59)  STI × Size                  0.02†    (0.01)    N  1265  1265  1265  1265  1265  1265  1265  1265  1265  Pseudo-R2  0.01  0.01  0.00  0.02  0.18  0.19  0.18  0.20  0.21  AIC  2938  2956  2960  2913  2433  2414  2437  2401  2365  BIC  2969  2986  2991  2955  2484  2465  2488  2462  2442  Wald chi-square  33.0**  14.7**  11.0**  62.7**  326.3**  349.1**  324.6**  353.4**  362.6**  Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.69**  −0.80**      −0.83**  −0.86**  (0.30)      (0.29)  (0.25)      (0.24)  (0.24)  Shareholder ret.    −0.26**    −0.28**    −0.36**    −0.37**  −0.12    (0.07)    (0.07)    (0.07)    (0.07)  (0.09)  S-T investment      0.08**  0.08**      −0.06**  −0.05*  −0.25*      (0.02)  (0.02)      (0.02)  (0.02)  (0.12)  Profitability          8.50**  9.21**  8.33**  9.41**  12.02**          (0.94)  (0.94)  (0.95)  (0.95)  (1.15)  Leverage          −3.35**  −3.48**  −3.51**  −3.42**  −3.38**          (0.38)  (0.37)  (0.38)  (0.37)  (0.37)  Liquidity          0.53*  0.43†  0.53*  0.50*  1.11**          (0.22)  (0.22)  (0.22)  (0.22)  (0.37)  Firm size          0.74**  0.71**  0.81**  0.73**  0.66**          (0.05)  (0.05)  (0.06)  (0.06)  (0.06)  Share × Profit                  −3.50**                  (0.77)  Share × Liquidity                  −1.44*                  (0.59)  STI × Size                  0.02†    (0.01)    N  1265  1265  1265  1265  1265  1265  1265  1265  1265  Pseudo-R2  0.01  0.01  0.00  0.02  0.18  0.19  0.18  0.20  0.21  AIC  2938  2956  2960  2913  2433  2414  2437  2401  2365  BIC  2969  2986  2991  2955  2484  2465  2488  2462  2442  Wald chi-square  33.0**  14.7**  11.0**  62.7**  326.3**  349.1**  324.6**  353.4**  362.6**  ** P < 0.01, * P  < 0.05, † P  < 0.10; two-tailed. In Models 5 through 9, we see that the control variables are all significant predictors of issuer ratings and in the expected directions. Profitability, liquidity and firm size have significant positive effects on S&P corporate credit ratings, while leverage has a significant negative effect. The coefficient for specialization, an indicator of firm emphasis on core competencies, is negative and significant in all of the models where it is present, though the effect size is reduced once the control variables are introduced. The coefficient for shareholder return, an indicator of firm emphasis on shareholder value, is also negative and significant, but the effect size grows once the controls are added. Finally, STI, an indicator of firm emphasis on financial investments, is positive and significant in the models without controls, and negative and significant in the models with controls. The coefficients for the variables reflecting firm emphasis on core competencies, shareholder value and financial investments are all significant and negative in the full first-order model (Model 8). This suggests that rating analysts view engaging in these practices as independently detrimental to firms in the long term. Firms with high SRs, that therefore earn most of their profits from a single or limited number of industries, are less likely to receive higher credit ratings from Standard & Poor’s net of covariates. S&P discourages emphasis on shareholder value as well. Those firms with higher levels of shareholder return in the 2 years prior to their rating are less likely to receive higher ratings net of their size and level of profitability. Finally, those firms with a greater amount of short-term financial assets are less likely to receive higher ratings net of the liquidity that those assets provide. The changes in the three explanatory variables across the models in Table 1 are logically consistent. Firm size and specialization have a significant negative correlation (r = −0.21), which should not be surprising considering that multidivisional firms tend to be larger in size. When firm size is introduced into the model, the negative effect of specialization is reduced because the influence on ratings due to its correlation with smaller firms is parsed out. Similarly, shareholder return is significantly correlated with profitability (r = 0.17). Profitable firms are more likely to pay dividends and have increasing stock prices. Therefore, the negative effect of shareholder return on credit ratings is suppressed in Models 2 and 4 because profitability has a positive impact on ratings. When profitability is added to the model, the negative effect of shareholder return grows because the suppressor has been removed. Finally, STI is significantly correlated with liquidity (r = 0.18). Stocks, money market funds, short-term bonds and other similar financial assets are very easy to cash in. In Models 3 and 4, the interaction between these two variables causes STI to appear to be positively correlated with ratings. However, once liquidity is controlled for, the true relationship between financial investments and ratings becomes clear. Financial assets outside of the liquidity that they bring to a firm are frowned upon by S&P. Model 9 introduces statistically significant second-order interaction effects. For more profitable firms with higher levels of liquidity, the effect of emphasizing shareholder return on credit rating becomes more negative (i.e. the magnitude of the negative relationship between shareholder return and credit rating grows). This finding tells us that the ‘better’ a firm is doing in the financial sense (i.e. more liquid and profitable), the more that S&P negatively assesses emphasizing shareholder return. There is also a weak interaction between STI and firm size as well. Though excessive financial profits are punished with lower ratings, the effect is attenuated for larger firms. The parallel-regressions assumption is violated for firm size and STI. This implies that the relationship between these variables and credit rating is nonlinear, as the regression coefficients for these variables differ across each threshold (i.e. these variables affect the probability of being in a higher rating category differently depending on the rating category). Firm size is always a positive significant predictor of rating regardless of the threshold (α < 0.01). The influence of STI decreases with increasing threshold and ultimately is no longer a significant predictor of rating across the low- to high-investment grade threshold. This tells us that though financialization is generally a significant predictor of credit rating, it is not important for differentiating between highly rated firms. When we compare the Moody’s models in Table 2 to the S&P models in Table 1, we see that the agencies are very consistent in their treatment of the model variables when generating ratings. All of the coefficients in the Moody’s models are significant and in the same direction as the S&P models except for when we introduce second-order interactions. Table 2. Predicting Moody’s corporate bond ratings Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.62**  −0.80**      −0.82**  −4.09*  (0.34)      (0.33)  (0.29)      (0.28)  (1.73)  Shareholder ret.    −0.40**    −0.39**    −0.52**    −0.51**  −0.30**    (0.10)    (0.10)    (0.11)    (0.11)  (0.11)  S-T investment      0.09**  0.09**      −0.07**  −0.07**  −0.07**      (0.03)  (0.03)      (0.03)  (0.02)  (0.02)  Profitability          7.60**  8.93**  7.54**  9.11**  12.01**          (1.09)  (1.13)  (1.11)  (1.14)  (1.33)  Leverage          −3.63**  −3.85**  −3.90**  −3.79**  −3.86**          (0.50)  (0.49)  (0.50)  (0.49)  (0.49)  Liquidity          2.98**  2.66**  2.97**  2.77**  2.46**          (0.53)  (0.52)  (0.52)  (0.51)  (0.51)  Firm size          0.89**  0.87**  0.99**  0.89**  0.64**          (0.07)  (0.06)  (0.07)  (0.07)  (0.15)  Spec. × Size                  −0.37†                  (0.20)  Share × Profit                  −3.92**                  (1.07)    N  1150  1150  1150  1150  1150  1150  1150  1150  1150  Pseudo-R2  0.01  0.01  0.00  0.02  0.21  0.22  0.21  0.22  0.23  AIC  2643  2649  2656  2618  2115  2096  2114  2083  2061  BIC  2673  2680  2686  2658  2166  2146  2165  2144  2134  Wald chi-square  24.7**  14.5**  11.3**  53.5**  289.7**  306.3**  287.9**  314.5**  316.3**  Variable  Model 1  Model 2  Model 3  Model 4  Model 5  Model 6  Model 7  Model 8  Model 9  Specialization  −1.70**      −1.62**  −0.80**      −0.82**  −4.09*  (0.34)      (0.33)  (0.29)      (0.28)  (1.73)  Shareholder ret.    −0.40**    −0.39**    −0.52**    −0.51**  −0.30**    (0.10)    (0.10)    (0.11)    (0.11)  (0.11)  S-T investment      0.09**  0.09**      −0.07**  −0.07**  −0.07**      (0.03)  (0.03)      (0.03)  (0.02)  (0.02)  Profitability          7.60**  8.93**  7.54**  9.11**  12.01**          (1.09)  (1.13)  (1.11)  (1.14)  (1.33)  Leverage          −3.63**  −3.85**  −3.90**  −3.79**  −3.86**          (0.50)  (0.49)  (0.50)  (0.49)  (0.49)  Liquidity          2.98**  2.66**  2.97**  2.77**  2.46**          (0.53)  (0.52)  (0.52)  (0.51)  (0.51)  Firm size          0.89**  0.87**  0.99**  0.89**  0.64**          (0.07)  (0.06)  (0.07)  (0.07)  (0.15)  Spec. × Size                  −0.37†                  (0.20)  Share × Profit                  −3.92**                  (1.07)    N  1150  1150  1150  1150  1150  1150  1150  1150  1150  Pseudo-R2  0.01  0.01  0.00  0.02  0.21  0.22  0.21  0.22  0.23  AIC  2643  2649  2656  2618  2115  2096  2114  2083  2061  BIC  2673  2680  2686  2658  2166  2146  2165  2144  2134  Wald chi-square  24.7**  14.5**  11.3**  53.5**  289.7**  306.3**  287.9**  314.5**  316.3**  ** P < 0.01, * P < 0.05, † P < 0.10; two-tailed. Only two of the second-order interaction terms are significant in the Moody’s model. Just like in the S&P model, the negative effect of shareholder return on credit rating is stronger for more profitable firms. Unlike the S&P model, there is a negative interaction between specialization and size. This means that though rating agencies punish all firms that emphasize core competencies, they punish larger firms more harshly for doing so. Also, like the S&P models, the parallel-regressions assumption was violated for firm size and short-term investment yielding identical nonlinear behavior. 8. Discussion Sociological scholars have focused on documenting and explaining the isomorphic spread of shareholder value as a guiding logic in US corporate firms. As discussed in the second section above, the emergence of shareholder value oriented management has led to the proliferation of specific corporate practices that serve the interests of equity investors. But recent literature emphasizing the institutional logics approach to understanding organizational behavior has been critical of research centered on isomorphism (Thornton and Ocasio 2008). It has argued that ‘new institutional’ approaches obscure heterogeneity of key constructs such as efficiency, rationality and participation in organizational fields while simultaneously treating these concepts as neutral and deterministic. There are often conflicting institutional logics in a given organizational field, market or industry. The existence of conflicting logics in the inter-institutional system allows for contradiction and change to existing dominant logics in an organizational field (Thornton and Ocasio, 2008). Dominant logics are frequently supplanted by subsidiary or conflicting ones as their legitimacy becomes contested (Thornton and Ocasio, 1999; Kitchener, 2002; Lounsbury, 2002, 2007; Zajac and Westphal, 2004; Greenwood and Suddaby, 2006). For example, Scott etal. (2000) and Reay and Hinings (2005) found that a single dominant institutional logic in the healthcare field transitioned into three unique logics that coexist in a relatively stable fashion. This paper draws on the finance literature to demonstrate that there is not a single, consistent market logic (Thornton and Ocasio, 1999, 2008) permeating corporate finance, but instead the conflicting market logics of debt and equity investment. The shareholder value approach is a manifestation of the broader logic of equity investment. This logic of how a firm should function only reflects the interests of a certain set of investors, and according to leading theories of corporate finance, is often opposed to another logic guiding the values and behaviors of debt investment. The field of corporate finance is multi-dimensional (Graham and Smart, 2012) and the logics of these dimensions are not necessarily aligned. Rational means of leveraged financing (e.g. issue bonds and take on a lot of debt) are at odds with downside risk management5 5 The term ‘downside risk management’ is used here instead of the more generic term ‘risk management’ to avoid potential confusion that might be caused by Power’s (2005a,b, 2009) work on ‘enterprise risk management’ (ERM), which he argues is an emerging risk based conception of corporate control. ERM is a practice of corporate internal risk management that attempts to control risks threatening ‘company value’. This new conception of control, which rose to prominence in conjunction with the legitimacy of Credit Risk Officers, is argued to be an instantiation of the corporate logic of shareholder value and therefore follows the logic of equity investment. (e.g. reduce exposure by eliminating debt). Bond rating agencies, being more concerned with firm survival over growth, rely more heavily on the logic of debt investment. Through the above examination of qualitative and quantitative data from the two largest bond rating agencies, it is clear that for more than a decade, bond rating agencies, powerful actors in corporate finance that have been demonstrated to influence issuer behavior, discourage practices linked to shareholder value and the logic of equity investment. This is due to the fact that they serve the interests of debt investors and are therefore guided by a logic that leading financial theories argue is at odds with shareholder value and equity investment. Both major bond rating agencies, Moody’s and Standard and Poor’s, discourage firm specialization and strict emphasis on core competencies. They provide significantly lower ratings to those firms that focus on generating profits in a single or few industries. Moody’s and S&P also punish firms that emphasize shareholder returns. The above models find that the more firms produce short-term increases in share price and dividend payouts to shareholders independently of profits and firm size, the less likely they are to receive higher ratings. Finally, both major bond rating agencies have been negatively sanctioning financial investments beyond the added liquidity that they provide. The above models find that those firms with more short-term financial investments are less likely to receive higher ratings once we control for liquidity. This implies that rating agencies are concerned with excess STI. According to the models above, the major bond raters believe that short-term financial investments are a detriment to long-term firm health outside of their potential to generate cash flow. This research suggests that what is deemed economically rational in the world of corporate finance is inconsistent between types of social actors. The adoption of three specific strategies by corporate executives that are believed to be rational, efficient means for growth and future firm success—emphasizing core competencies, shareholder returns and financialized profits—are consistent with the logic of equity investment. In contrast, major bond rating agencies are drawing on the logic of debt investment which views the very same practices to be detrimental to future firm health. Given that organizational scholars have become increasingly wary of the progressive dominance of shareholder value oriented management, these findings highlight an important question. To what degree does resistance to the logic of equity investment exist in the field of corporate finance? It has been documented that the rights of debt investors have been expanding via changing corporate reorganization laws in the USA providing more control for creditors (Skeel, 2003). But this added control for debt investors comes after a firm has already gotten itself into serious financial trouble, potentially by following the logic of equity investment. The dominance of bond financing as the primary form of corporate financing in the USA might generate a stronger mechanism for resisting shareholder value in corporate governance. As bond financing continues to grow, and the bond market continues to increasingly trade at higher relative rates than equity (Schwarcz, 2017), it is logical that the sanctions by bond rating agencies which undermine SVO practices will become increasingly important to understanding corporate governance in the USA. However, despite resistance from major rating agencies in the form of lower ratings, organizational scholars continue to observe convergence toward many SVO behaviors by firms rather than away from them. It is likely that corporate managers, who have been demonstrated to account for corporate ratings in their decision making, have a hierarchy of governance strategies that they rely on when making decisions based on competing incentives. They are constantly trying to manage contradictory rationalizations in order to please different social actors; specifically those endorsing the logic of equity investment vs. debt investment. The push and pull felt from a range of organizations in the field of corporate finance (e.g. institutional investors, shareholders, board members, regulators, securities analysts, etc.) guide decision-making within the corporate organization and lead to the adoption or avoidance of different behaviors. Though their firm’s bond rating is important to managers, satisfying their board, institutional investors, or even their own pocketbooks may take greater priority. If corporate governing boards, under the influence of institutional investors, tie financial incentivizes to shareholder value, then corporate managers may be willing to take the hit to their corporate credit rating for boosting shareholder returns if it leads to a larger pay bonus in the short term. Though downside risk management is a concern, it might not be as much of a priority for corporate managers as other dimensions of corporate finance. This explanation is consistent with claims made by Ocasio (1997) who argues that institutions structure the attention of social actors embedded within them. Institutional logics focus the attention of decision makers (e.g. corporate managers) by providing a set of interests and identities as well as a guide to the ‘importance, and relevance of issues and solutions’ (Thornton and Ocasio, 2008). Conflicting logics in a given field create competing interests and issues that need resolution. Corporate managers, given their unique social position, can identify and exploit differences in corporate finance logics to advance the interests that they’ve internalized as priorities (often their own) (Fligstein, 1987; Battilana, 2006). They understand the importance of firm leverage and liquidity to their credit rating, but also understand the importance of meeting analyst expectations in order to boost stock prices. They juggle and strategically employ contradictory logics (such as the logics of equity and debt investment) in order to meet the competing demands being placed upon them. This article demonstrates that future sociological research on corporate governance in the USA needs to recognize the potential resistance to shareholder value oriented management by powerful agents reflecting the interests of debtholders. There are multiple avenues this research might take. First, the degree to which the one logic dominates the other is in need of exploration. Current research on US corporate governance seems to have concluded that the logic of equity investment has come to dominate corporate management. Is the logic of equity investment continuing to spread despite resistance from external actors in corporate finance representing the interests of debt investment (bond rating agencies, hedge funds), or is the logic of debt investment gaining a stronger foothold in recent years given the increased importance of bond vs. equity issuance in corporate finance? Second, future research needs to examine the extent to which corporate managers are juggling these competing demands. Past research shows that managers are sensitive to their firm’s credit ratings. Why then has there been a continued emphasis on de-diversification, shareholder returns, and financialized profits despite the negative sanctions being levied by rating agencies? Is it due to a hierarchy of priorities whereby debtholder concerns are given lower priority? Or instead, is it possible that rating agencies are not clear in signaling which behaviors are discouraged by debtholders? Third, we need a further understanding of how these logics interact. Are debtholders and equity holders always in direct competition? Theories of finance suggest that the alignment of these competing interests varies by the financial health of the firm they are invested in such that there will be more alignment between debt and equity interests in financially riskier firms with poor financial health. Our statistical models show inconsistent findings. For both Moody’s and S&P, the more profitable a firm, the more punishment there is for emphasizing shareholder returns. S&P also penalizes highly liquid firms more for shareholder returns. Our findings imply that the stronger the firm’s financial position (via high profitability, and in the case of S&P, high liquidity as well), the greater the disdain for equity driven shareholder returns. In other words, there is greater divergence of equity and debt interests for firms with stronger financial health, as theories of finance would predict. However, we also find that in both the Moody’s and S&P models, the effect of STI (net of liquidity) is nonlinear and only a significant predictor for differentiating high risk companies. This implies that financialized profits are not a concern of bond rating agencies for financially healthy firms. Therefore, debt and equity interests are only at odds over the equity-driven practice of financialized profits for firms with weaker financial positions contrary to expectations from theories of finance. These findings suggest that the relationship between the logics of equity and debt investment is not necessarily as straightforward as theories of finance would suggest. Further investigation should identify under which situations these logics are at odds, and when they might instead be aligned, potentially producing constructive interference and mutually reinforcing specific behaviors. Under conditions of alignment of debt and equity investment logics, we would expect isomorphic trends. Finally, sociological scholars have spent much time and energy evaluating the ‘shareholder value myth’. Drawing on Meyer and Rowan’s (1977) theory of institutional myths, it has been argued that the corporate governance model committed to the maximization of shareholder value is not necessarily superior to older models of governance, despite its popularity (Dobbin and Zorn, 2005). This implies that the logic of equity investment is not necessarily a rational guide to firm success. Isn’t it also possible that the logic of debt investment possesses myth-like qualities? For example, it might be the case that diversification is not always beneficial to the long-term success of firms, as major bond rating agencies appear to believe. It is apparent from this research, that the behavior of bond rating agencies is consistent with the logic of debt investment founded in financial economic theories. But these theories might not be consistently accurate reflections of empirical reality. Is it possible that rating agencies are guided by flawed logic? Further research needs to evaluate the degree to which rating decisions reflecting the logic of debt investment reliably predict firm default. Major bond rating agencies have been implicated in contributing to the collapse of the housing market by knowingly engaging in unlawful behavior while rating mortgaged-backed securities (Taibbi, 2013). This led to S&P’s recent settlement with the Justice Department for $1.38B, the largest penalty ever paid by a rating agency (Davidson etal., 2015). However, it is possible that outside of the documented malfeasance of ‘bad actors’ in the rating industry, major rating agencies might be promoting institutional myths about which practices are optimal for generating long-term firm success. Further investigation is warranted. 9. Conclusion This research contributes to the sociological literature on finance and corporate governance. It argues that the shareholder value oriented management model in US corporate firms is a manifestation of a broader logic based in financial economic theory; that of equity investment. Additionally, there exists a logic of debt investment that competes for the attention of corporate managers. The logic of debt investment has been largely ignored by the non-financial behavioral sciences. This article demonstrates that influential social actors in the field of corporate finance subscribe to this logic of debt investment, and it calls for additional examination of the influence of debt investment on US corporate governance, especially given the increased dominance of debt financing among US corporate firms. At a time when debt financing is more important than ever, we need to understand how the SVO model will begin to recede, or alternatively, explain why it continues to flourish despite opposition from an increasingly influential set of actors. Additionally, this paper hopes to call greater attention to the role that bond rating agencies play in corporate governance. Though there have been a few limited studies examining rating agencies and corporate governance (Ashbaugh-Skaife etal., 2006; Attig etal., 2013; Louizi and Kammoun, 2016), they fail to locate the motives of these agencies in a broader logic based in theories of financial economics, and are therefore limited in their explanatory power. Further, most of the economic research examining the influence of debt investment on corporate governance focuses on banks and debtholders. Given their potential for influencing corporate management (see Section 5 above), and the evidence from this paper demonstrating that these actors have been negatively sanctioning SVO corporate strategies, additional examination of how bond rating agencies influence US corporate governance and the spread of shareholder value oriented strategies is necessary. This research also contributes to the institutional logics literature. It is clear that corporate finance is a field in which there are multiple logics operating simultaneously, demonstrating the complexity of the market logic that guides the rationale of corporate firms. We can think of these conflicting logics as complementary social forces that provide balance for firms. The logic of equity investment seems to push for relatively risky endeavors that might lead to innovation and growth. The logic of debt investment pushes against risk, and emphasizes stability. Corporate managers are simultaneously guided by these opposing logics and ideally generate a balance for their firms between short-term growth and long-term stability. Finally, these findings have important implications for the financial industry as well. If embracing SVO practices is detrimental to long-term firm survival as many critics suggest, then the negative sanctions provided by bond rating agencies are good for the financial system as a whole (in terms of stability). However, it appears that corporate managers continue to employ these practices despite the demonstrated negative impact on rating. This implies that the balance between these conflicting logics of corporate finance has been tipped in the favor of equity investment as the interests of corporate executives and even fund managers become aligned with shareholders (Widmer, 2011; Jung and Dobbin, 2015). Future research should examine how corporate managers decide when to respond to the pressures placed on them by rating agencies, as well as what potential collaborative arrangements are used to reconcile the conflicting logics (Reay and Hinings, 2005). The extent to which specialization, shareholder returns and financial profits are detrimental to long-term firm success should also be explored. The shareholder value myth has become central to the rationale of financial actors following the logic of equity investment. 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