Should the world worry about America’s corporate-debt mountain? | Hacker News Reader

Should the world worry about America’s corporate-debt mountain?

economist.com

19 pointsindigodaddy21 comments

Corporate debt is fundamentally just a piece of capital structure and tax arbitrage. It's not really something that is that concerning.

Fundamentally, the overall value of a company is independent of how it is financed. You can sell some standard bonds, issue some of those senior to other ones, issue common and/or preferred stock, convertible bonds, whatever. End of the day there's assets and expected cash flows, and all the various tranches add up to the whole thing.

So, why do companies like debt instead of equity? It has advantageous treatment in the tax code. If your company is financed entirely by equity and it earns $100M in profits, you get taxed on the full $100M. If you sell bonds that pay out $20M in interest each year, your taxable profits are now $80M instead of $100M.

The people buying these corporate bonds are all fully aware that they behave like equity. Capital structure arbitrage firms will actually hedge their long or short corporate bond positions by taking offsetting equity positions - buy the bond, short the stock, and collect the excess yield. So it's not really any sort of moral thing with having lots of corporate debt out there, mostly just an anomaly in how claims on corporate assets are divvied up in order to end up paying less in taxes.

Wait... but bonds these days are usually issued to fund stock buybacks, which inflates the stock price. Why would you short the stock in that case?

You short the stock because it has price moves in the opposite direction of the bonds, so you can afford to buy more bonds without undue risk of losses. Like, the trade has several pieces:

1. Buy the corporate bond, getting the credit spread over equivalent treasuries

2. Short the same face value of stock, which gives you back the price of the bonds in case of bankruptcy.

3. Buy call options on the stock to close out your short position, costing you the option premium to go into the trade.

Also, stock buybacks don't (or at least shouldn't) increase stock prices.

It would increase stock price as this results in fewer stock owning larger part of the company. 10 stock for a billion valued company. It buys back 2 shares now the same company is owned by 8 share some of the value will come down as less cash reserves but if it is a company with growing revenue and profits the individual share price will go up.

The decrease in cash reserves should exactly cancel out the decrease in outstanding shares. Buybacks still help corporate executives, though. They have stock options, and buybacks make the stock price more sensitive to profits (since the company is smaller because it has less cash on hand).

But if you have issued a lot of debt, does that not expose you to risk when the interest rate changes?

Additionally, don’t you think it’s true that companies are issuing debt to buy back their own stock, which they then intentionally overpay for in order to drive up the stock price?

Interest rate risk isn't a huge deal for issuers when rates are this low - not much room for rates to fall. And even if it did become significant, the futures market has very effective tools for hedging various kinds of interest rate risk.

>Additionally, don’t you think it’s true that companies are issuing debt to buy back their own stock, which they then intentionally overpay for in order to drive up the stock price?

Stock buybacks are replacing dividends for tax reasons - they both make the overall value of publicly traded shares lower by giving cash to shareholders. Dividends trigger income tax by replacing share price with cash in hand, while buybacks reduce the publicly traded float at the same price and only triggers capital gains for the shareholders who wish to sell into the buyback.

I was more referring to the risk of interest rates going up- would that not mean that the debt has to be either repaid or rolled over into a new loan at a higher rate, when it matures? What if the fed raises rates like it did during the volker shock- if you owe a lot of cash and the rates go that high, does your company not become insolvent?

Only if the rates are adjustable. I'm not sure how common a financial advisor for a company would ok that, but I'll guess...almost never.

Well they don’t have to be adjustable though right? I mean it doesn’t feel like this is debt that is ultimately being paid off, but rather just rolled over into new loans, on some schedule right? So when you roll it over, you might have to do so at a higher rate.

I mean I’m not seeing companies go, ok we’re going to swap debt for equity here but then we’re going to pay all this debt off. The debt is permanent.

If you've issued long-term bonds and rates go up, you can buy back your own bonds below par and earn a profit (depending on rate movements etc). And when it matures, you can likely issue more stock if the cash flow situation of your company hasn't changed. The only route for insolvency is if you've used debt issuance to pull more cash out of the company than the actual equity slice should have been worth.

That makes sense, but my guess is unfortunately that that is exactly what companies are doing, mostly because the ceo gets a sizable bonus when the stock price goes up.

How do stock buybacks work for companies that are net diluting?

I.e. a company pays employees with 2n stock units and buys back n stock units.

Is that akin to a ponzi?

I would say that that’s exactly what’s happening. You pay employees with stock, but then you buy back your stock to inflate the price, financing the buybacks with debt. The ceo gets a huge bonus, and then when the stock price crashes because the debt has to be repaid, the employees are left with a big pile of worthless stocks. The ceo flees with a golden parachute.

Probably. The only thing that's driven the economy since 2009 is the suppression of wages, technology-based productivity boosts, and the hindsight to know that the US Government is ready and willing to bail out any sufficiently large industry.

How does wage suppression drive the economy? If less people have money to spend wouldn't there be less economic activity?

When the cost of labor stays the same while productivity increases due to technological advances (e.g. moving from an in-house server farm to the cloud), profit increases.

Not necessarily. I know it is slightly pedantic to point this out, but technical advances does not imply "free technical advances". e.g. you may increase productivity without increases in wages but not increase profits if the technical progress is driven by paid improvements in technology (which tends to me a multiplier on capital).

So, for example, if you get a new versions of excel, which improves your productivity $100/year, but excel costs $100 this year to upgrade, you haven't gained anything in year 1. That will be a multiplier, but, if the upgrades cost a lot up front (e.g changing technology stack causes initial decrease in productivity and obsolescence of some internal IP + change costs, training, etc) and the productivity increase will be small then it may not be obvious that there is an economic benefit for quite some time.

Of course, a lot of companies think this way and failure to just ditch a lot of old tech years ago, ends up massively holding back productivity relative to peers that did make the upgrades. As a result the company sees low per capita productivity and decides not to raise wages.

Note: this is theory I do not have actual academic studies in practice that can demonstrate this explicitly in a controlled environment, but anecdotal experience certainly makes me suspect that this is what is going on.

edit: grammar

> So, for example, if you get a new versions of excel, which improves your productivity $100/year, but excel costs $100 this year to upgrade, you haven't gained anything in year 1.

Yes, but this is a tautology (it will always be true that making a capital expenditure of $x/employee/year to augment surplus value $x/employee/year will break even). Productivity itself is scalar (units produced/time), so to arrive at a dollar amount of $100 additional revenue generated per employee would suggest an incredibly small increase in units produced over 1 year.

That’s where the finance industry steps in. If you suppress wages and push a private debt bubble then you get the profit and the government bails out the banks when the bubble bursts.

> technology-based productivity boosts

Productivity increase is the underlying force behind all non-government-spending economic growth

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