Credit Ratings, Incentives, and How "Safe Companies" Become Dangerous

Most investors assume a company with an AA or AAA credit rating must have outstanding management.

That assumption is understandable — but it is wrong.

A credit rating does not evaluate today's management team. It evaluates the financial legacy they inherited.

A company earns an exceptional credit rating through decades of conservative borrowing, disciplined capital allocation, careful risk management, and executives willing to sacrifice short-term gains for long-term stability. Those decisions are often made by leaders who retired years before today's executives arrived.

Think of it like inheriting a century-old family farm. The new owner didn't plant the orchards, build the irrigation system, or improve the soil. They simply inherited the results of generations of stewardship.

Corporate America works much the same way.

A newly appointed CEO can inherit an extraordinary balance sheet built by predecessors who spent decades creating financial strength. That strength can hide poor decisions for years because the company has enough financial resilience to absorb mistakes before investors recognize the damage.

By the time the credit rating deteriorates, the destruction has often already occurred.

For decades, Montana Power represented exactly the type of company conservative investors loved. It generated dependable cash flow. It paid reliable dividends. It carried little financial risk.

Many retirees — including my own parents — owned Montana Power because it appeared to be one of the safest investments available.

Then everything changed.

New executives inherited an exceptionally strong company but pursued an entirely different vision. Rather than operating a stable regulated utility, management decided to chase the excitement of the late-1990s telecommunications boom.

The company sold the utility assets that had produced stable earnings for generations and reinvented itself as Touch America, a fiber-optic telecommunications company.

The timing could hardly have been worse. Within only a few years, the telecom bubble collapsed, revenues evaporated, debt mounted, and the company filed for bankruptcy.

What disappeared wasn't simply shareholder wealth. A century of disciplined capital allocation vanished because the incentive structure changed.

The executives who built Montana Power viewed themselves as stewards. The executives who followed viewed themselves as capital allocators pursuing rapid growth.

The balance sheet did not fail first. The incentives did.

If Montana Power demonstrates how financial strength can be squandered, Boeing demonstrates how corporate culture can change just as dramatically.

For generations Boeing was synonymous with engineering excellence. Its reputation wasn't built through clever accounting. It was built through extraordinary engineering.

Engineers occupied leadership positions. Product quality defined the company's identity. Safety wasn't simply another performance metric — it was the culture.

Following the merger with McDonnell Douglas, however, leadership priorities gradually shifted. Financial performance metrics assumed increasing importance, executive compensation became more closely tied to earnings per share and total shareholder return, and billions of dollars were directed toward stock repurchases.

The consequences were subtle at first. Research spending became less important. Engineering decisions increasingly competed with quarterly financial targets. Management attention shifted toward meeting performance metrics instead of strengthening engineering capability.

None of these changes produced immediate headlines. But together they fundamentally altered the organization's priorities.

The tragic 737 MAX accidents were not caused by a single bad decision. They reflected years of accumulated decisions influenced by changing incentives.

My own view is straightforward.

If a company truly has excess capital that it cannot reinvest at attractive rates, it should return that capital to its owners through dividends.

Every shareholder is treated equally. Every investor receives the same distribution. Each shareholder can then decide independently whether to reinvest those funds, purchase shares elsewhere, or simply spend the money.

Stock buybacks work differently. They reduce the number of shares outstanding, increasing earnings per share even if total earnings remain unchanged. Because executive compensation is frequently tied to earnings per share, total shareholder return, and stock price performance, buybacks often become more than a capital-allocation decision — they become part of the executive compensation system.

When the same executives deciding whether to authorize buybacks also benefit from higher per-share metrics, that creates an inherent conflict of interest.

Shareholders should carefully examine whether the buyback primarily benefits the company — or management.

That doesn't mean every buyback is undertaken for improper reasons. It does mean investors should evaluate buyback programs with healthy skepticism and pay close attention to the incentives surrounding them.

One lesson emerges from both Montana Power and Boeing.

Corporate decline rarely begins with deteriorating financial statements. It begins with changing incentives.

Credit ratings measure yesterday's discipline. Annual reports tell management's preferred story. Quarterly earnings describe recent performance.

But incentive structures reveal where the company is likely to go next.

Whenever you evaluate a company, ask questions that most investors never ask. How is management compensated? Which performance metrics determine bonuses? Does executive wealth depend upon long-term value creation — or short-term stock performance? Are buybacks increasing shareholder wealth — or simply increasing executive compensation?

Those questions often reveal far more than another spreadsheet ever will.

Markets are ultimately shaped by human behavior. Human behavior is shaped by incentives.

If we want to understand why corporations succeed, fail, innovate, or stagnate, we need to look beyond earnings releases and analyst ratings.

We need to ask a much simpler question:

Who benefits from the decisions being made?

When you consistently follow the incentives, corporate behavior begins to make sense.