Why do large, well-established companies typically receive higher bond ratings compared to start-ups? A. They are able to manipulate rating agencies to secure better ratings. B. They are assumed to have sound financial management and sufficient liquid assets to meet bond obligations. C. They are subject to less scrutiny from rating agencies than start-ups. D. They are rated highly because they issue fewer bonds than start-ups.
The correct answer and explanation is:
Correct Answer: B. They are assumed to have sound financial management and sufficient liquid assets to meet bond obligations.
Explanation:
Large, well-established companies typically receive higher bond ratings than start-ups because credit rating agencies like Moody’s, Standard & Poor’s, and Fitch evaluate the creditworthiness of a bond issuer. These agencies look at a variety of factors, including:
- Company’s financial stability
- Historical performance
- Cash flow and profitability
- Debt-to-equity ratios
- Market presence and competitiveness
Established firms often have diverse revenue streams, strong balance sheets, and track records that show they can successfully manage debt and economic fluctuations. These factors reduce the perceived risk of default, which leads to higher credit ratings (e.g., AAA, AA), signaling to investors that lending to these companies is relatively safe.
In contrast, start-ups usually lack:
- Long-term financial records
- Proven profitability
- Large cash reserves
This makes their future earnings less predictable and their ability to repay debt more uncertain, leading to lower bond ratings (such as B or below), which indicate a higher risk to investors.
Now let’s look at why the other options are incorrect:
- A. “Manipulating rating agencies” is not a legitimate or widespread practice, and agencies operate independently to preserve their credibility.
- C. “Subject to less scrutiny” is false; large companies often receive more attention due to the scale and impact of their debt on the financial markets.
- D. “Issue fewer bonds” is incorrect—larger companies often issue more bonds than start-ups because they have the size and investor trust to do so.
In summary, the superior credit ratings of large companies reflect their financial strength, stability, and proven ability to meet debt obligations, not favoritism or reduced oversight.