Social Sciences History Seminar

Abstract: We examine the introduction of the first-ever letter-graded ratings for corporate securities. In 1909, John Moody surprised markets when he published a book containing assessments of the credit risk for the majority of listed railroad bonds. These inaugural securities ratings had no regulatory implications and were largely predictable using publicly available information. Despite this, we find that lower than market-implied ratings caused a sudden rise in secondary market bond yields. Using an instrumental-variables design, we show that bonds that received a rating at all experienced a substantial decline in their bid-ask spreads. These results suggest that ratings reduced information asymmetries and improved liquidity. Our findings are consistent with assessments of credit risk into coarse groupings improving information transmission, even in settings with the highest monetary stakes and well-incentivized participants, and highlight the potential value of ratings unencumbered by regulatory implications or distortions from issuer-pays models for the functioning of financial markets.