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Andras Danis, assistant professor of finance
Andras Danis, assistant professor of finance

Georgia Tech Researcher: Increasing Financial Leverage Could Benefit Companies

Many profitable, publicly traded corporations may be leaving money on the table by not issuing more debt, increasing their financial leverage, according to Andras Danis, an assistant professor of finance at Georgia Tech Scheller College of Business.

“A lot of firms tend to be very conservative,” says Danis, who recently published the paper, “Refinancing, Profitability and Capital Structure” in the Journal of Financial Economics.

That conservative streak might seem to contradict the well-established trade-off theory that companies seek to find an optimal balance between debt and equity financing in order to realize benefits such as reduced taxes, Danis notes. Some other studies have questioned this textbook trade-off theory, suggesting that if it were accurate, then firms would carry much higher debt levels than they do in reality.

However, Danis says his study shows that firms do behave consistently with the trade-off theory. As an example, he points to Apple’s 2013 selling of $17 billion of bonds to help finance a $100 billion capital reward for shareholders.

For many years, Apple had not carried any debt, financing itself totally through equity. But the time became right to rebalance its capital structure, helping the company avoid repatriation taxes on funds held overseas, he says.

Many companies would not want to rebalance every year, Danis explains, because of the significant investment banking fees and other costs involved. “But once companies experience several years of high or low profitability, then they will rebalance. They remain inactive for a time, and then switch.”

One problem of some past studies that questioned the trade-off theory of capital structure was that they examined all the years of a company, including inactive periods when rebalancing might not have been prudent because of the considerable costs of refinancing, Danis says.

Still, Danis and his co-authors (Daniel A. Rettl of the Humboldt University of Berlin and Toni M. Whited of the University of Rochester) were surprised by their findings that so many firms carry no debt on their balance sheets. The researchers examined the behavior of thousands of firms over multiple years.

“Chief Financial Officers may want to seriously consider issuing more debt and paying out the proceeds to equity holders in order to increase the value of their firms,” Danis says. “Of course, you don’t want to take on too much debt and move a company closer to bankruptcy.”

 [User1]Daniel is now at Humboldt University of Berlin. 


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