Corporate bonds, credit ratings and the availability of credit in crises – meet professor Bo Becker
The fun in finding things out – that’s what motivated professor Bo Becker to choose an academic career. His work offers lessons about what makes credit markets deep and resilient to crisis, and he has a couple of recommendations for reforms for policy makers.
“In research, you have to first be motivated by your own passion. You cannot be too concerned about received wisdom. Eventually, of course, you must influence other people: attention to your research is a sign that the work you are doing is important”, he says.
For professor Bo Becker from the Swedish House of Finance, an academic career was an option he considered as a student at the Stockholm School of Economics (SSE). He worked in management consulting after graduation, but after a few years Bo enrolled in a PhD program at SSE, then transferred to the University of Chicago.
“I wanted to get to the bottom of things, to work thoroughly and scientifically. Finding things out is so much fun”, says professor Bo Becker.
He graduated with a PhD from the Booth School of Business at the University of Chicago in 2004. Before joining SSE as professor in 2013, he worked at the University of Illinois and Harvard Business School.
Bo’s research lies in the field of corporate credit markets, much of it concerning the connected topics of credit cycles, credit ratings and the resolution of insolvency.
Why do you find corporate credit markets important?
“Corporate credit, such as bank loans and bonds, constitutes the bulk of external financing for corporations. Essentially, without corporate credit markets, you have no modern economy. Credit is the simplest way of transferring resources, and it requires much less effort from investors than equity – less upfront understanding and analysis to make the funding decision as well as less monitoring and intervention afterwards. This makes credit a cheap and efficient mechanism for funding companies. Therefore, deep, stable credit markets are a key to a healthy economy.”
One question that has triggered Bo’s curiosity is what factors can limit the size and depth of corporate credit markets. One such factor is the system for handling insolvency, when firms cannot pay their debts. This includes both the formal bankruptcy system in court and less formal methods of restructuring companies out of court. Recent work with Jens Josephson of Stockholm University highlights that the insolvency system is not sufficiently well developed in many European countries.
“My assessment is that corporate bond markets in Europe are much less developed than they could be. It’s difficult to invest in bonds from weaker companies, as you don’t know what will happen in case of insolvency. This is a problem in Sweden, as well as in many other European countries.”
The US has a system based around Chapter 11 of the US bankruptcy code. It’s a sophisticated, complex and exceptionally well-functioning instrument for resolving insolvency – and has been honed over forty years, Bo Becker explains.
“By generating good outcomes in insolvency, Chapter 11 also supports a deep, efficient and healthy credit market for firms. Europe, not least Southern Europe, urgently needs this. Chapter 11 cannot easily be copied, however, as the legal system is different from what we have in Europe. So we need to study what components of Chapter 11 that can be used in a European context.”
The upside for Europe would be considerable, according to Bo: both in getting better insolvency outcomes, and in allowing more companies to get credit at reasonable terms.
“It could allow European corporate credit markets to diversify away from the heavy reliance on domestic banks. This could make the European economy more robust and more resilient to problems in national banks”, Bo states.
Bo’s research on credit ratings has received a lot of attention – particularly the finding that competition between credit rating agencies has sometimes lead to lower quality ratings.
“The basic conflict is that rating agencies receive their revenue from the companies they rate”, explains Bo. “Rating agencies have a long-term interest in maintaining their reputation as reliable providers of information. But short term profits tend to be higher when issuing favorable ratings. Competition in this type of environment is problematic, because it simultaneously reduces the value of reputations, because future industry profits will be lower, and exacerbates the need to entice issuers to choose you over the other agencies. Obviously, one dimension on which to compete is the level of ratings.”
Bo’s recent work with Ramin Baghai of the Swedish House of Finance has documented that companies which purchase consultancy services from a rating agency tends to receive higher ratings from that agency. This offers further evidence on this conflict.
What consequences does your research on credit ratings have for policy?
“There are two main conclusions I’ve drawn from this work, and two reform areas. Number one is that competition, unlike in most markets, is a negative force in ratings. Encouraging competition, which has been a major thrust of regulation in both the US and Europe, is problematic. With modest competition, companies certainly make excessive profits, but may produce better ratings, and that is very important for functioning credit markets.”
“A related point”, Bo continues, “is that the commercial relationship between rating institution and their clients is the source of problems in this area. One possible remedy is transparency. For example, in annual reports, companies could be asked to reveal how much they have paid rating agencies, just as they are required to reveal how much they pay accounting firms. This would have the potential to limit the risk of bias in corporate ratings.”
Outside of his research, Bo Becker has many engagements, as a board member, expert or advisor. He previously served on the board of directors of the Swedish National Debt office (Riksgäldskontoret). He serves as the program director for the research program Mistra Financial Systems (MFS).
“Sustainability is a major issue for the financial system. One example is that the financial sector has not always delivered retail products that worked well for households who have too often ended up with expensive, underdiversified portfolios. Today, when defined contribution pensions dominate the system, poor investment outcomes can have a devastating impact on the quality of life in retirement. This is one of the many issues investigated in the projects funded by MFS”, Bo Becker says.
What’s most fun about your job?
“A great thing about this job is finding things out. That’s what attracted me to the job in the first place. It doesn’t happen every day, but when you have something new, and can produce the evidence to convince the profession, that’s a treasure.
I also find it fascinating to talk about the topics I love with those who are interested in the same thing – this includes other researchers, but also people in industry, policy-makers and, of course, my own students.
And third, higher education is a wonderful thing. At the individual level, a high quality, science-based, well-taught education can be a career-deciding as well as a life-altering experience. The value of living in a high human capital society is immense for everyone: it’s the whole difference between the wonderful modern economy and what came before. So both for the individual and for society at large, I feel that this activity is a special one. And it’s amazing to be part of that.”
Why is Swedish House of Finance important?
“The Swedish House of Finance has made possible collecting a fantastic group of international researchers working on the central topics of finance. The research coming out of this group puts us among the best in Europe. This then underpins a great set of courses and executive programs, and is reflected in the benefit our research-based point of view can provide for the financial industry in Stockholm and beyond, and for policy makers in Sweden and Europe, and for public discourse at large”, says Bo Becker.