Leverage and financing of non-financial companies: an international perspective
BIS Economic Papers No 27
The financing mix and leverage of non-financial companies have historically differed substantially across countries. This paper explores possible reasons for this range of experiences. In the process it provides a broader perspective from which to assess a typically US phenomenon which has recently focused the attention of policy-makers, academics and the public at large: the wave of highly leveraged transactions (HLTs) which has dramatically raised the debt burden of a significant number of corporations. Leveraged buy-outs (LBOs) have been the most conspicuous facet of this trend.
Section I provides a stylised picture of differences in financing patterns and leverage, with a more detailed discussion of definitional issues being relegated to Appendix I. Section II briefly summarises the main lessons which can be drawn from the theory of financing decisions and leverage which is reviewed in more detail in Appendix II. The theory is then used to explain basic financing patterns and cross-country differences. Section III applies the general theoretical framework to the interpretation of the wave of HTLs in the United States and considers the prospects for similar developments in other countries.
Among the conclusions reached, at least four deserve particular attention.
While the traditional stylised distinction between low-leverage countries (e.g. the United States, the United Kingdom and Canada) and high-leverage countries (Japan, Germany, France and Italy) still provides a useful classification, differences have tended to narrow since the early 1980s.
The unique experience of the United States is a primary factor behind the lower dispersion of leverage levels across the two groups of countries. In contrast with all other countries in the sample, US companies have retired substantial amounts of equity, substituting them with debt.
A number of complementary, and partly overlapping, factors could in principle explain leverage and financing patterns: taxation, investment needs in relation to internal availability of funds, and institutional characteristics favouring particular financing forms. Above all, examination of historical cross-country differences suggests that in high-leverage countries a number of institutional features primarily related to investor/ company relationships have been conducive to the support of relatively high debt burdens. These characteristics tend to increase informational flows to lenders and reduce the costs of resolving financial crises, notably through long-term relationships between borrowers and lenders. Three such characteristics are lower fragmentation of debt claims, simultaneous holding of debt and equity, and government policy. There is little evidence that the increase in US corporate indebtedness has been accompanied by a convergence towards those characteristics of high-leverage countries which would point towards greater debt capacity, although some such elements can be found in HLTs. The new financial structures may indeed raise the efficiency and profitability of segments of the company sector by bringing managers' incentives more into line with those of equity holders and by reducing their leeway to pursue other goals. Even so, they also imply greater vulnerability to system-wide shocks such as an economic downturn.
At least three characteristics are critical for the feasibility of US-style HLTs: availability of low-grade debt finance, a liquid stock market for the refloating of companies and dispersed ownership, if hostile bids are to succeed. Only in the United Kingdom and, to a lesser extent, France have HLTs reached significant volumes. The growth potential for these operations does exist in the other Group of Seven countries, but primarily on a friendly basis. Hostile operations would require further institutional changes. Above all, however, the spreading of HLTs outside the United States will depend on how restructured companies are in the next economic downturn.