Credit Ratings and their Agencies

Further, auditing can be conducted via “Internal Auditors” and “External Auditors”2 (CFI). They are appointed by a company’s shareholders (“Appointment of Auditors as per Companies Act | Procedure”). As the auditor provides an objective and an independent opinion for assurance of an organization’s financial statements, it, in turn, brings several benefits to the shareholders, such as maintaining consistency, detecting frauds and finding errors in their processing. Other than this, because the nature of their report is unbiased, it even advises the people involved (the board of directors, shareholders, etc) in the company what necessary changes, precautions can be incorporated.

Moreover, adequate financial statements for any company would increase investors’ confidence in their investments. Whereas without proper regulations and standards in place, companies rely on strategies like “window-dressing” , in which a company misrepresents its financial statements to portray them as more profitable than they truly are. Thus, to review the authenticity and appropriateness of the financial position of a company, auditing is crucial.

The shareholders want the best for the company, and therefore select an auditor for their honest opinions on the financial statements of the company. In large companies like IL&FS, the investors also appoint a management to look after the company and its workings. There are instances of corruption where the auditors collude with the management and present dishonest opinions to the public. This is harmful to all the investors involved in the company. To gain the investor’s trust, credit rating agencies evaluate the risk associated with investment in the company based on the company’s credit history and the audit reports.

Credit Ratings and their Agencies

Bonds released/managed by bond markets3 have to be evaluated to determine the risk of default on a bond issue, and this can be ensured by providing credit ratings. Before granting a financial instrument to an individual or a company or a firm, a possible credit risk analysis is done, which is determined by the creditworthiness and the credentials provided by the individual or the company. This analysis is what is defined as “Credit rating” . Credit Rating is determined after evaluating the liabilities and assets (ClearTax, 2020), and whether their fixed-income securities will be able to meet their obligations (Finney, 2019). Credit Rating Agencies (CRAs) are considered the gatekeepers which determine whether a company is worth

2 The company/firm employs internal auditors and they are deemed to ensure that internal financial controls are in place. On the other hand, external auditors are independent statutory auditors who examine the books and accounts and give a reasonable assurance of whether the financial statements are free from material misstatements.

3 Bond markets are essentially financial/credit markets that deal with issues and trades related to debts. As stated by James Chin, former head of research at Gain Capital, “Governments typically issue bonds in order to raise capital to pay down debts or fund infrastructural improvements. Publicly-traded companies issue bonds when they need to finance business expansion projects or maintain ongoing operations. ” (Chen, 2020) 9