Application of the Modigliani–Miller Theory in Rating Methodology

Chapters 6– 8 and 9– 11 suggest a new approach to rating methodology. Chapters 6– 8 are devoted to rating of non-financial issuers, while Chaps. 9– 11 are devoted to long-term project rating and rating of arbitrary duration projects. The key factors of a new approach are (1) the adequate use of discounting of financial flows virtually not used in existing rating methodologies and (2) the incorporation of rating parameters (financial “ratios”) into the modern theory of capital structure (Brusov–Filatova–Orekhova (BFO) theory) (in Chap. 6 into its perpetuity limit - Modigliani and Miller theory). This on the one hand allows us to use the powerful tools of this theory in the rating, and on the other hand, it ensures the correct discount rates when discounting financial flows. We also discuss the interplay between rating ratios and leverage level which can be quite important in rating. All these create a new base for rating methodologies. New approach to ratings and rating methodologies allows us to issue more correct ratings of issuers and makes the rating methodologies more understandable and transparent.