10

Inspired by this question.

In one personal finance book I read that if a company is located in a country with credit rating X it can't have credit rating better (lower - i.e. further from AAA level) than X. The explanation was the following: country has rating X because risk of doing business with it is X and so risk of doing business with any company located in that country automatically can't be better than X.

Does this always hold true? Can a company have credit rating better than that of the country where it is located?

  • Could be if it is a government corporation. – DumbCoder Aug 10 '11 at 13:13
7

BlackJack's answer is technically correct: government credit ratings are independent of corporate credit ratings. The rating should reflect the borrower's ability to repay its obligations.

One reason the book you read may have stated that corporate credit ratings cannot be better than the government's credit rating is that the government, unlike the corporation, can steal (or in government parlance "tax") from anywhere or anyone. So if a government finds itself in financial difficulty it could simply take the cash from corporations or people with high credit ratings by a variety of methods: implement windfall profit taxes, take over industries, take peoples gold, tax pension savings, or simply take peoples pensions or retirement savings. This increases the risk of doing business in a country with an over-extended government.

Over extended governments do not die gracefully. They only die when there is nothing left to steal.

11

In one personal finance book I read that if a company is located in a country with credit rating X it can't have credit rating better (lower - i.e. further from AAA level) than X.

This is simply wrong. Real world evidence proves it wrong. Automatic Data Processing (ADP), Exxon Mobile (XOM), Johnson & Johnson (JNJ), and Microsoft (MSFT) all have a triple-A rating today, even though the United States doesn't. Toyota (TM) remained triple-A for many years even after Japanese debt was downgraded.

The explanation was the following: country has rating X because risk of doing business with it is X and so risk of doing business with any company located in that country automatically can't be better than X.

When reading financial literature, you should always be critical. Let's evaluate this statement. First off, a credit rating is not the "risk of doing business." That is way too generic. Specifically, a credit rating attempts to define an individual or company's ability to repay it's obligations. Buying treasuries constitutes as doing business with the gov't, but you can argue that buying stamps at USPS is also doing business with the gov't, and a credit rating won't affect the latter too much.

So a credit rating reflects the ability of an entity to repay it's obligations. What does the ability of a government to repay have to do with the ability of companies in that country to repay? Not much. Certainly, if a company keeps it's surplus cash all in treasuries, then downgrading the government will affect the company, but in general, the credit rating of a company determines the company's ability to pay.

  • 3
    One point to be made regarding all the companies you cite as examples, all of them are international in nature, with operations in many places around the world, sales around the world, etc. A truly domestic company with no operations outside it's home company may find it harder to get a rating above that of the country where it is located. – Chuck van der Linden Aug 16 '11 at 19:05

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .