Corporate Credit Analysis for the New Millenium

April 1, 2002 — In recent years new wave security analysis techniques, such as pro-forma earnings and price-to-sales ratios, were used to justify frothy security valuations. Terms such as cash flow, leverage and liquidity were passé. Investors shunned fixed income in favor of the next hot IPO. But now times have changed because in today’s world the equity market increasingly takes its cue from the bond market. Indeed, investors are struggling to find their way in a post-Enron world where balance sheets and income statements do not appear to be worth the paper they are written on. Moreover, auditors’ independence and objectivity have been called into question, further weakening investor confidence. A study by the Wall Street Journal indicates that 73% of the total fees paid by companies to their auditing firms in the Dow Jones Industrial Average during 2001 were for non-audit services. What about the rating agencies one may ask? Moody’s and Standard & Poor’s have increasingly come up a day late and a dollar short in protecting investors. In 2001 ten issuers were rated investment grade one year prior to default and Enron retained its investment grade rating up until one month prior to default.