Why do companies pay rating agencies such as Moody’s and S&P to rate the bonds they are selling?
Companies pay rating agencies such as Moody’s and S&P to rate their bonds, and the costs can be substantial. However, companies are not required to have their bonds rated; doing so is strictly voluntary. Why do you think they do it?
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Because having a higher rating assigned to the bonds they are offering makes them much easier to sell. The whole purpose of a company issuing bonds is to raise capital for expansions, remodeling, factory upgrades, etc., so they want to be able to sell the bonds in a reasonable amount of time, and those investors who buy large amounts of bonds typically only do so with those that are low risk.
The problem with companies paying rating agencies to rate their bonds is that there is a disincentive for those agencies to rate accurately. This started back in the 1970s, and since their income is partially based on how many companies come to them for such ratings, then there is pressure to rate bonds more highly than they deserve. This is, in part, what led to the huge sub-prime mortgage crisis in the United States, a prime cause of the current recession.
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