Abstract: Effects of the Introduction of Securities Ratings in the Early Twentieth Century

Eric Hilt, Carola Frydman, and Asaf Bernstein


In 1909, John Moody published the first letter-graded ratings for corporate securities in the United States, in a volume that rated the bonds of railroads. This paper studies the effect of the introduction of credit ratings on securities markets and on firms’ financial policies.  Using newly collected data on bond prices, bond ownership, and corporate balance sheets and income statements, we measure the effects of the ratings on bond yields and trading volumes, and on railroads’ costs of debt finance and leverage.  The results indicate that the ratings had a substantial impact on markets.  Bonds that were rated accounted for a substantially higher share of NYSE trading following the publication of the ratings.  Moreover, bonds whose ratings were a positive surprise to investors—in the sense that the rating was higher than the ratings for other bonds with similar yields—experienced a small but statistically significant increase in price.  The railroads whose bonds received those ratings saw their interest costs fall, and issued more debt—their leverage ratios increased by 15 percent of the pre-ratings mean.  These results indicate that even in the absence of ratings-based regulations, the introduction of ratings was a fundamentally important institutional innovation in financial markets.