The Rebirth of the Corporate Bond Market
, John Raven
& Christopher Chua
Published: June 2001
There has been a major switch from equity to debt finance in recent years,
associated with a fall in the long-term rate of interest. The paper explores the
macro-economic causes of the sea change in interest rates (lower budget deficits,
independent central banks, lower inflation expectations) and the micro-economic
consequences. Firms are taking on more debt partly for tax reasons and partly
because at lower interest rates they have better interest cover. This means they
can increase their borrowing at lower risk and hence at lower cost.
An examination of a cross section of UK firms from the FTSE 350 shows two
major influences on the debt-to-value ratio of large firms. Firms with healthy cash
flow are allowed to borrow against that income; and firms whose income is
relatively invariant across the economic cycle (as measured by a low asset beta)
can afford a higher level of debt.