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