2. A Historical Study on the Evolution of Risk Assessment and Credit
2.5. The Emergence of the First General Profit-seeking Organisations for the
As previously discussed, mutual societies for the protection of trade were organisations originated in the United Kingdom that exchanged credit information only between their members and were characterised by their non-profit seeking nature. In the United States, this kind of information sharing device could not be established most likely because of the vast geographical differences existing between the two countries.
Nevertheless, the size of the American territory, combined with the rapid increase in the mobility of resources that characterized the United Sates from the 1830s required an information sharing system other than the informal exchange of letters of recommendation that had prevailed in an economy in which trade took place in very limited geographic areas. As trade was performed between distant suppliers and customers, the system of acquiring credit information through personal knowledge no longer sufficed; therefore, the necessity for “information on suppliers and customers of whom a businessperson had no knowledge increased”33. In effect, a rapidly growing population along with the rapid increase in the construction of canals and railroads and the considerable expansion of the volume of trade, especially in the antebellum years, made the need for knowledge about distant and unknown customers, a primary concern for merchants.
32 Elijah W. Morgan, correspondence with American Collecting Agency. Morgan Family Papers, ca. 1830-1900, Box 1, Michigan Historical Collections, Bentley Historical Library, Ann Arbor. In Olegario (2001), p. 17.
33 Sylla (2001), p. 7.
International banking houses, such as the House of Brown, hired agents in order to obtain credit information on existing and potential customers, but as discussed earlier, the costs derived from this method were considerable, and only the largest investment and merchant houses could afford it. In order to satisfy this somewhat more sophisticated credit information need of small and medium firms (with insufficient means to pay a private agent) realising trade credit, a new form of organisation appeared for the first time in the United States in 1841: the credit reporting agency. Since its inception, American credit reporting agencies, unlike British mutual societies for the protection of trade, were profit-seeking organisations that provided credit information to every credit grantor that requested it in exchange of a constant amount of money. Credit reporting agencies adopted a centralised structure with branches in various parts of the country providing the central office with credit reports from businesses operating in their respective area and, at the same time, supplying local credit grantors with information requested on customers from the region. This structure reflected the specific needs of the United States stemming from its vast geographical area and the high mobility of its resources in the nineteenth century.
It is evident that, since the years preceding the American Civil War, the old informal system of acquiring credit information through personal ties was not only imperfect but also inadequate to the rapidly evolving business needs; as reported by James Madison in a 1974 article “The inadequacy of existing methods of gaining credit information was demonstrated during the economic crisis of the 1830s and the early 1840s, when many merchants discovered that their earlier trust in some of their customers had been ill-founded. At the same time, rapid changes in the financial condition of individual businessmen made clear the need for more up-to-date information.34” There is an extensive literature on the history of the first American credit reporting agency, the Mercantile Agency, started in 1841 by Lewis Tappan, a New York dry goods and silk merchant;
however, the difference with the present study is that the latter inserts the development of the methods for gaining credit information, by this and other credit reporting agencies, within a historical context that aims primarily to explain the evolution of information sharing devices in the nineteenth century in the United States and the United Kingdom.
Although the Mercantile Agency was the first centralised, profit-seeking agency to innovate in the field of providing credit information to businesses in the United States, the Bradstreet Agency, founded in 1849, can also be considered as one of the initiators of the
34 Madison (1974), p. 166.
credit reporting movement in the nineteenth-century America. Both evolved in the same developing business environment and both (competing agencies) tried to cover the deficiencies in the existing information reporting methods used at the time. But financial problems after 1865 prevented the Bradstreet Agency from developing as fast as the Mercantile Agency until the last quarter of the nineteenth century, when it became a serious challenger to Dun’s leadership35. Moreover, it is worth noting that Tappan’s solution to the problem of acquiring reliable credit information can be interpreted as a reaction to the Panic of 1837, a crisis generated by a cascade of defaulted debt, and to the emerging new business conditions in the United States in the antebellum years; indeed, the initiator of the Mercantile industry was one of the many businessman affected by the unreliability of extant traditional methods for gaining credit information: as a wholesaler and a partner in a dry goods house in New York, he experienced first-hand the difficulty to obtain reliable information on his customers.
Given that Lewis Tappan already possessed credit information on many of his own customers, and that he knew the value of this information for many a business at the time, the solution he proposed consisted on the creation of an agency operating on a national scale and able to collect information on all sorts of potential recipients of credit in order to sell it to wholesalers and all sorts of grantors of credit interested in this kind of information. The method used to obtain credit information recalls the one used in the early nineteenth century by the large London houses; merchants, bank cashiers, newspaper editors, postmasters and, especially lawyers were hired as correspondents (agents) on a local basis in order to take advantage of their constant access to credit-relevant information about businessmen living in their towns and villages across the country. They submitted reports to the central office, located in New York, in the case of the Mercantile Agency once a year. These reports contained basically the occupation of the subject, a parsimonious estimate of his assets, as well as a status of his business. Moreover, similarly to Wren Ward’s reports for Baring Brothers and Company, the character of the subjects was a very relevant question in the analysis of creditworthiness in many of the reports addressed to the agencies. As a contemporary account explains:
“Hence the main object with the agency is, to furnish the home standing of the merchant obtained from intelligent and reliable sources, there. . . . There, and only there, can [w]e learn whether he owns property, and is a man of good character—
35 The Mercantile Agency adopted different names; as Madison (1974) reports, it was known as Lewis Tappan & Co.
(1841-1849), Tappan & Douglas (1854-1859), and R. G. Dun & Co. (1859-1933). See also Dun and Bradstreet (1966).
whether he does a legitimate or a speculative business—and whether he is competent, steady, and attentive, or otherwise.36”
Adding to the information on the character of the businessman, his assets and the state of his business, additional information on marital status, family background, age, former residence, and business experience was usually included by the correspondents in their reports. In order to give an example of a typical report, we reproduce one written in 1846 on a Cincinnati dry goods merchant:
“A self-made man, age ab[ou]t 50, marr[ie]d, mem[ber] of Ch[urch] & in bus[iness]
n[ea]r 20 y[ea]rs, owns R[eal] E[state] w[orth] $20m unincumb[ere]d, tho[ugh]t to be a g[oo]d bus[iness]man, maintain his standing, in g[oo]d cr[edit], & consid[ere]d g[oo]d.37”
What was the aim of these reports? As Josh Lauer accurately reports: “At a fundamental level, these reports served just two purposes, both of which were predictive:
estimating the individual's chance of success in business, and gauging the likelihood of securing repayment, particularly in the event of failure. Toward this end, the key information was encapsulated in what would later be formalized as the "three C's" of credit reporting: character, capacity, and capital.38”
In fact, there was not uncommon for correspondents to send reports to the central offices that contained only the individual’s general reputation within the town or village in which he lived. The problem with this kind of information was that, as the reporters were not directly paid for their services by the agencies, in the beginning, there was the perception that the reports could be inaccurate and somewhat biased by informal practices such as rumours and even gossip circulating among people of doubtful motivations39. As can be observed from the example, even very general past payment behaviour commentaries of the individual in question were absent in the reports and the information provided is more anecdotal in nature than systematically obtained. This problem in gaining accurate credit information by the early agencies was the result of their hiring part-time agents that were not directly paid; in effect, the agents were compensated within a scheme
36 "The Mercantile Agency," Hunt's Merchant's Magazine, 24 January 1851, 47–48. In Lauer (2008), p. 309.
37 Dun Credit Ledgers, Ohio, Vol.78, p. 59, Dun & Bradstreet Collection (Baker Library, Graduate School of Business Administration, Harvard University). In Madison (1974), p. 167.
38 Lauer (2008), p. 309.
39 See Atherton (1946). In fact firms such as Baring Brothers and Company in London and Brown Brothers continued to rely on their own credit ratings. Additionally, some firms in the east of the United States preferred to continue to rely on their members or employees for estimates of the financial status of customers.
consisting of the mutual provision of services with the credit reporting agencies. In the case of lawyers, the agencies used to direct their subscribers’ debt collection business in exchange for information on the credit subjects. As to the newspaper editors, their compensation amounted to the agencies’ contribution in obtaining subscriptions and advertisements for the local newspaper. Other types of compensation discussed by Rowena Olegario include “recommending their correspondents as agents for insurance and steamship companies” and forwarding “requests from firms looking for representatives to sell their stock to the public”, in the case of lawyers and bankers respectively40. This compensation schemes were dependent upon the accuracy and timeliness of the reports provided by the agents, and undoubtedly contributed to the development of the early agencies, nonetheless, these could hardly verify ex ante the precision of the information contained in such documents.
There were in fact numerous critiques to the insufficient coverage across the country as well as the incompleteness of the credit information that added to the early mistrust from the general business population (Wyatt-Brown, 1966). Therefore, the elevated cost in reputational capital for the agencies in cases where the veracity of the reports was proven deficient, made them undertake gradual improvements in their methods for gaining credit information. First of all, they introduced full-time, paid reporters from the years preceding and during the Civil War, and, as discussed by Madison, by the 1870s, the majority of agents operating in major cities were already full-time employees. At the same time, this direct contact with the employees allowed the agencies (in particular R. G. Dun & Co.) to have an enhanced control over the methods used to collect information and the necessary training for the reporters. Full-time paid reporters in larger cities were divided according to their areas of specialty; each reporter was in charge of a particular field of trade in order to optimize the quality of the reports through their abilities to assess the creditworthiness of those subjects and firms involved. Moreover, hard financial data evenly supplanted pure personal opinions on the character of businessmen:
from the 1970s reporters not only asked specific questions about the business, but also required company balance sheets or financial statements through pre-printed forms prepared by the agencies. Reporters were trained to rely less on anecdotal forms of acquiring credit information and more on hard financial data from a variety of sources including personal interviews with businessmen. Finally, where inconsistencies were identified in the reports of the remaining part-time agents, still present in small towns and
40 Olegario (2001),p. 15. See also Olegario (2000).
villages, full-time reporters were in charge of corroborating the information, which enhanced the quality of the documents as well as the reputation of the agency.
With regard to the dissemination of credit information, credit reporting agencies also gradually adopted new approaches in order to enhance quality. Initially, a subscriber requesting information on a potential customer used to call at the agency’s offices in order to have the credit report read aloud by a clerk, but later, the agencies opened branches in different cities in order to decentralise the dissemination of information and divide it by geographical areas. Additionally, in 1857, the Bradstreet agency innovated with the publication of a Reference Book containing all the credit information on individual businesses; the Mercantile Agency followed only two years later. In this way, subscribers could use this book whenever they needed it without having to recur constantly to direct communication with the agencies’ offices. However, the problem with the reference books was that they were published on an annual basis, and therefore, in the course of the year, changes in the standing of the credit conditions of potential customers resulted in outdated information. Branches of the agencies were thus used in order to solve this problem:
reporters submitted updated credit information to their respective local offices and these branches were in charge to copy and transmit the information to the central office.
Subscribers were thus able to get updated credit reports for a particular subject just by calling to their local branch, which was responsible for a specific trade region and to which reporters in the area provided with the solicited information.
This system was not perfect as this network system worked very well only for subscribers seeking information about customers located in the same city or town; those subscribers established in a city other than the one in which the central office was located, and who were seeking information for distant customers, had to make the request and wait for the central office to coordinate the transmission of information between the concerned areas. The delays resulting from this network structure were indeed the object of criticisms from subscribers. It was not until the 1850s, when the telegraph was well established within the agencies’ communications that the solution to this problem commenced to emerge.
Later, the use of the typewriter in the 1870s greatly facilitated the task. Overall, the role in the dissemination of credit information by the American reporting agencies was crucial in the development of new methods both in the United Sates and the United Kingdom, the latter starting the process with mutual societies and the hiring of agents to collect information, and the former establishing centralised profit-seeking reporting agencies with new methods of dissemination and collection of information.