The Capital Structure Shuffle

June 11, 2024 | Thomas Neuhardt, Research Associate

In the years following the Global Financial Crisis, issuing new debt was an easy decision for companies looking to raise capital given an environment of historically low interest rates. That said, decisions related to the composition of corporate capital structures are now less straightforward due to seismic shifts in monetary policy that have taken place in recent time. To that point, this week’s chart compares the yield-to-worst of the Bloomberg U.S. Corporate Bond Index, a proxy for the cost of debt, to the earnings yield of the S&P 500 Index. The earnings yield is calculated by dividing earnings-per-share by the price of the index and is used as a proxy to determine the costs companies face when it comes to new equity share issuance (i.e., the lower the earnings yield, the cheaper it is to sell shares and vice versa). As readers can observe in the chart above, this yield now sits below the yield-to-worst of the fixed income index.

Companies generally prefer issuing debt over equity due to the tax shield associated with this financing (i.e., interest expenses are typically tax-deductible), which still renders debt the more cost-efficient option for many companies in the current environment. Further, equity issuance is often viewed negatively by market participants due to the dilution of per-share earnings that arises as a result.  There are, of course, additional factors beyond the costs of debt and equity that CFOs must consider when making decisions related to capital structure dynamics. That said, in light of the trends outlined above, many companies may begin to view equity issuance as a more attractive option when it comes to raising capital.

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