The Price of Im­per­fec­tion �Peter Coy, with Sridhar Natara­jan and Michelle F. Davis

Bloomberg Businessweek (North America) - - Markets/ Finance -

sky­rocket when a com­pany falls into the CCC’S. The sen­si­ble spot is some­where be­tween the ex­tremes.

One in­di­ca­tion that fads af­fect fi­nanc­ing de­ci­sions is that lever­age ra­tios swing wildly. For com­pa­nies in the S&P Com­pos­ite 1500 in­dex, they’ve jumped lately. The av­er­age ra­tio of net debt to earn­ings be­fore in­ter­est, taxes, de­pre­ci­a­tion, and amor­ti­za­tion rose from 0.7 in 2006 to 1.9 in 2015. “The idea of boost­ing re­turns in a de­lib­er­ate debt-funded way has be­come more ac­cept­able,” says An­drzej Sk­iba, a money man­ager at Blue­bay As­set Man­age­ment.

Bor­row­ing to pay for div­i­dends and buy­backs will one day go out of style just as quickly as it’s come into style, says NYU Stern’s Damodaran. “You need the equiv­a­lent of a cor­po­rate Prozac to calm these guys down, be­cause they’re es­sen­tially bipo­lar,” he adds.

J&J de­nies it’s be­ing ir­ra­tionally con­ser­va­tive by cling­ing to all three of its A’s. “We’re very proud of the fact that we’re Aaa-rated, but we would not let that alone be a de­ter­mi­nant in whether or not we al­lo­cated cap­i­tal to in­crease share­holder value,” Do­minic Caruso, the com­pany’s chief fi­nan­cial of­fi­cer, told an­a­lysts last year. J&J an­nounced a $10 bil­lion share-re­pur­chase pro­gram in 2015 and this April raised its div­i­dend for the 54th con­sec­u­tive year.

Mi­crosoft, which has more than $100 bil­lion in cash and short-term se­cu­ri­ties, is so stuck on its AAA that it doesn’t even get ques­tions from an­a­lysts about it. The com­pany, which de­clined to com­ment, has steadily raised its div­i­dend and bought back shares—a demon­stra­tion that it doesn’t need to lose its AAA to re­ward share­hold­ers. Like­wise, an Exxonmo­bil spokesman says that de­spite the S&P down­grade, “noth­ing has changed in terms of the com­pany’s fi­nan­cial phi­los­o­phy or pru­dent man­age­ment of its bal­ance sheet.” Moody’s still gives the com­pany its top rat­ing.

Credit qual­ity doesn’t mat­ter only to in­vestors. Com­pa­nies that loaded up on debt in the early to mid-2000s were more likely than oth­ers to fire work­ers once the 2007-09 re­ces­sion hit, ac­cord­ing to a Na­tional Bureau of Eco­nomic Re­search work­ing pa­per is­sued last year. Weak bal­ance sheets were “in­stru­men­tal in the prop­a­ga­tion of shocks” dur­ing the cri­sis, Xavier Giroud of MIT’S Sloan School of Man­age­ment and Hol­ger Mueller of the Stern School of Busi­ness wrote in the re­port. De­ci­sions about debt may be idio­syn­cratic, but they’re def­i­nitely con­se­quen­tial.

Ad­di­tional yield, in per­cent­age points, for bonds S&P rates AA vs. AAA The bot­tom line For many com­pa­nies, us­ing their money to ex­pand or to make share­hold­ers happy is worth let­ting their AAA S&P rat­ing drop.

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