Dynamics of Corporate Finance: What Motivates Change?

The ratio of corporate debt and to GDP provides little insight into the reality of corporate finance. In contrast, patterns in net interest expense relative to operating surplus, current assets to current liabilities, and the financing gap provide cyclical patterns that serve as reliable guidelines—but not rules. Corporate financial leverage varies over the business cycle and therefore provides a cyclical character corporate credit quality in response to changes in interest rates, inflation, and the pace of economic growth. These three factors influence corporate choices of bank, bond, or equity finance, which themselves are the result of evolving cyclical activity. Tobin’s Q provides a gauge of the balance between the replacement costs of real assets and the market value of equities. Implementation of this benchmark as a tool illustrates the principle that many economic series are often more of a guideline rather than a rule.