Investing Politics: Globalization Backlash and Government Disruption!

    I will start with a couple of confessions. The first is that I see the world in shades of gray, and in a world where more and more people see only black and white, that makes me an outlier. Thus, if you are reading this post expecting me to post a diatribe or a tribute to Trump, tariffs or Tesla, you are likely to be disappointed. The second is that much of my work is in the micro world, where I look at companies and their  values, and the work that I do on macro topics or variables is to help me in that pursuit. Thus, my estimates of equity risk premiums, updated every month, are not designed to make big statements about markets but more to get inputs I need to value companies. That said,  to value companies today, I have no choice but to bring in the economics and politics of the world that these companies inhabit. The problem with doing so, though, is that with Trump and tariffs on the one hand, and Musk and DOGE on the other, it is easy to be reactive, and to let your political leanings drive your conclusions. That is why I want to step back and look at the two larger forces that have brought us to this moment, with the first being globalization, a movement that has shaped economics and markets for much of the last four decades, but that has now, in my view, crested and is facing pushback, and the other being disruption, initiated by technology start-ups in the 1990s, and extended to lay waste to the status quo in many  businesses in the decades since, but now being brought into the political/government arena.

Globalization – The Rise, Effects and Blowback

    Globalization has taken different forms through the ages, with some violent and toxic variants, but the current version of globalization kicked into high gear in the 1980s, transforming every aspect of our lives. I am no historian, but in this section, I will start with a very short and personal history of how globalization has played out in my classroom, examine its winners and losers, and end with an assessment of how the financial crisis of 2008 caused the movement to crest and create a political and economic backlash that has led us to today.

A Short (Personal) History of Globalization

    The best way that I can think of illustrating the rise of globalization is to talk about how it has made its presence felt in my classroom over the last four decades. When I started my teaching journey at the University of California at Berkeley in 1984, business education was dollar-centric, with business schools around the world using textbooks and cases written with US data and starring US companies. My class had a sprinkling of European and Japanese students but students from much of the rest of the world were underrepresented. The companies that they went to work for, after graduation, were mostly domestic in operations and in revenues, and multinationals were more the exception than the rule, with almost all of them headquartered in the United States and Europe. 

    Today, business education, both in terms of location and material, has become global, with European and Asian business schools routinely making the top business school list, and class materials reflecting this trend. My classes at NYU often have more students from outside the United States than from within,  and very few will go to work for entities with a purely domestic focus. Many of these hiring firms have supply chains that stretch across the world and sell their products and services in foreign markets. As businesses have globalized, consumers and investors have had no choice but to follow, and the things we buy (from food to furniture) and the companies that we invest in all reflecting these global influences. 

The Winners from Globalization

    As consumers, companies and investors have globalized, there have clearly been many who have benefited from its rise. Without claiming to be comprehensive, here is my list of the biggest winners from globalization. 

1. China: The biggest winner from globalization has been China, which has seen its economic and political power surge over the last four decades. Note that the rise has not been all happenstance, and China deserves credit for taking advantage of the opportunities offered by globalization, making itself first the hub for global manufacturing and then using its increasing wealth to build its infrastructure and institutions. To get a measure of China’s rise, I look at its GDP, relative to GDP from the rest of the world over the last few decades: 

   

   Source: World Bank

   China's share of global GDP increased ten-fold between 1980 and 2023, and its centrality to global economic growth is measured in the table below, where I look at the percentage of the change in global GDP each decade has come from different parts of the world: 
   
   Between 2010 and 2023, China accounted for almost 38% of global economic growth, with only the United States having a larger share, though the winnings for the US were on a larger base and are more attributable to the other global force (disruption) that I will highlight in the next section.
2. Consumers: Consumers have benefited from globalization in many ways, starting with more products to choose from and often at lower prices than in pre-globalization days. From being able to eat whatever we want to, anytime of the year, to wearing apparel that has become so cheap that it has become disposable, many of us, at least on the surface, have more buying power.
3. Global Institutions : While the World Bank and the IMF predate the globalization shift, their power has amped up, at least in many emerging markets, and the developed world has created its own institutions and  agreements (EU and NAFTA, to  name just two) making it easier for businesses and individuals to operate outside their domestic borders. In parallel, International Commercial Courts have proliferated and been empowered to enforce the laws of commerce, often across borders.
4. Financial Markets (and their centers): Over the last few decades, not only have more companies been able to list themselves on financial markets, but these markets has become more central to public  policy. In many cases, the market reaction to spending, tax or economic proposals has become the determinant on whether they get adopted or continued. As financial markets have risen in value and importance, the cities (New York, London, Frankfurt, Shanghai, Tokyo and Mumbai) where these markets are centered have gained in importance and wealth, if not in livability, at the expense of the rest of the world.
5. Experts: We have always looked to experts for guidance, but globalization has given rise to a new cadre of experts, who are positioned to identify what they believe are the world’s biggest problems and offer their solutions  in forums like Davos and Aspen, with the world’s policy makers as their audience. 

The Losers from Globalization

    When globalization was ascendant, its proponents underplayed its costs, but there were losers, and that list would include at least the following: 

1. Japan and Europe: The graph that shows the rise of China from globalization also illustrates the fading of Japan and Europe over the period, with the former declining from 17.8% of global GDP in 1995 to 3.96% in 2023 and the latter seeing its share dropping from 25.69% of global GDP in 1990 to 14.86%. You can see this drop off in the graph below:
   
   
   While not all growth from globalization is zero-sum, a significant portion during this period was, with economic power and wealth shifting from Europe and Japan to newly ascendant economies.
2. Consumers, on control: I listed consumers as winners from globalization, and they were, on the dimensions of choice and cost, but they also lost in terms of control of where their products were made, and by whom. To provide a simplistic example, the shift from buying your vegetables, fish and meat from local farmers, fishermen and butchers to factory farmers and supermarkets may have made the food more affordable, but it has come at a cost.
3. Small businesses: While there are a host of other factors that have also contributed to the decline of small businesses, globalization has been a major contributor, as smaller businesses now find themselves competing against companies who make their products thousands of miles away, often with very different cost structures and rules restricting them. Larger businesses not only had more power to adapt to the challenges of globalization, but have found ways to benefit from it, by moving their production to the cheapest and least restrictive locales. In one of my data updates for this year, I pointed to the disappearance of the small firm effect, where small firms historically have earned higher returns than large cap companies, and globalization is a contributing factor.
4. Blue-collar workers in developed markets: The flip side of the rise of China and other countries as manufacturing hubs, with lower costs of operation, has been the loss of manufacturing clout and jobs for the West, with factory workers in the United States, UK and Europe bearing the brunt of the cost. While the job losses varied across sectors, with job skills and unionization being determining factors, the top line numbers tell the story. In the United States, the number of manufacturing jobs peaked at close to 20 million in 1979 and dropped to about 13 million in 2024, and manufacturing wages have lagged wage growth in other sectors for much of that period. 
   
   
   
5. Democracy: In my view, globalization has weakened the power of democracy across the world. The fall of the Iron Curtain was greeted by optimists claiming the triumph of democracy over authoritarianism and the dawn of a new age of democratic freedom. That promise has largely been dashed, partly because the biggest winners from the globalization sweepstakes were not paragons of free expression and choice, but also because voters in democracies were frustrated when they voted for change, and found that the policies that followed came from a global script. The Economist, the newsmagazine, measures (albeit with their own biases) democracy in the world, and its findings in its most recent update are troubling.
   
   Not only does the world tilt more authoritarian than democratic in 2024, the trend line indicates that the world is becoming less democratic over time. While there are other forces (social media, technology) at play that may explain this shift as well, the cynicism that globalization has created about the capacity to create change at home has undoubtedly contributed to the shift away from democracy.

I believe that globalization has been a net plus for the global economy, but one reason it is in retreat  is because of a refusal on the part of its advocates to acknowledge its costs and the dismissal of opposition to any aspect of globalization as nativist and ignorant. 

The 2008 Crisis and its Aftermath

    Coming into this century, the march of globalization seemed unstoppable, but the wave crested in 2008, with the financial market crisis. That crisis exposed the failures of the expert class, leading to a loss of trust that has never been recovered.  While the initial public responses to the financial crisis were muted, the perception that the world was still being run by hidden (global) forces, unelected and largely unaccountable to anyone, has continued, and I believe that it has played a significant role in British voters choosing Brexit, the rise of nationalist parties in Europe, and in the elections of Donald Trump in the United States. Trump, a real estate developer with multiple international properties, is an imperfect spokesperson of the anti-globalization movement, but it is undeniable that he has tapped into, and benefited from, its anger. While he was restrained by norms and tradition in his first term, those constraints seem to have loosened in this second go around, and he has weilded tariffs as a weapon and is open about his contempt for global organizations. While economists are aghast at the spectacle, and the economic consequences are likely to be damaging, it is not surprising that a portion of the public, perhaps even a majority, are cheering Trump on.

    To those who are nostalgic for a return to the old times, I don't believe that the globalization genie can go back into the bottle, as it has permeated not only every aspect of business, but also significant portions of our personal lives. The world that will prevail, if a trade war plays out, will be very different than the one that existed before globalization took off. China, the second largest economy in the world today, is not returning to its much smaller stature, pre-globalization, and given the size of its population, it may be able to sustain its economy and grow it, with a domestic market focus. While investors are being sold the India story, it is worth recognizing that India will face much more hostility from the rest of the world, as it tries to grow, than China did during the last few decades. For Europe and Japan, a combination of an aging populations and sclerotic governments limit the chances of recovery, and for the United States, the question is whether technology can continue to be its economic savior, especially if global markets become more difficult to access.

Disruption – Origins and Extensions

    In the world of my youth, disruption was not used as a compliment and disruptors were consigned to the outside edges of society, labeled as troublemakers or worse. That has changed in this century, as technology evangelists have used disruption as a sword to slay the status quo and offer, at least, in their telling,  more efficient and better alternatives.

The Disruptor Playbook

    I have written about disruption in earlier posts, and at the risk of repeating myself, I will start with a generalized description of the playbook used by disruptors to break up the status quo.

1. Find a business to disrupt: The best businesses to disrupt are large (in terms of dollars spent on their products/services), inefficient in how they make and sell these products, and filled with dissatisfied players, where no one (or at least very few) is happy. For the most part, these businesses have made legacy choices, which made sense at the time they were made, have long outlived their usefulness, but persist, because systems and practices have been built around them, and changes are fought by the beneficiaries of these inefficient systems.
2. Target their weakest links: Legacy businesses have a mix of products and services, and it is inevitable that some of these products are services have high margins and pay for other products that are offered at or below cost. Disruptors go after the former, weaning away unhappy customers by offering them better deals, and in the process, leaving legacy businesses with a less profitable and viable product mix.  
3. Move quickly and scale up: Speed is of the essence in disruption, since moving quickly puts status quo companies at a disadvantage, as these companies not only take more time to respond, but must weather fights within their organizations, often driven by politics and money. With access to significant capital from venture capital, private equity and even public investors, disruptors can scale up quickly, unencumbered by the need to have well formed business models or show profits at least in the near term.
4. Break rules, ask for permission later: One feature shared by disruptive models, albeit to varying degrees, has been a willingness to break rules and norms, knowing fully well that their status quo competitors will be more averse to doing so, and that the rule makers and regulators will take time to respond. 
5. There is no alternative: By the time the regulators or legal system catches up with the disrupters, they aim to have become so ascendant, and the status quo so damaged, that there is no going back to the old ways.

In the last three decades, we have seen this process play out in industry after industry, from the retail business (with Amazon), the music business (with Apple iTunes first and Spotify later), the automobile business (with Tesla) and advertising (with Google and Facebook), to name just a few.

Disruption's Winners and Losers

    The obvious winners from disruption are the disruptors, but since many of them scaled up with unformed business models, the payoff is less in the form of profits, and more in terms of their market capitalizations, driven by investors dazzled by their potential. That had made the founders of these businesses (Bezos, Musk and Zuckerberg) not only unbelievably wealthy, but also given them celebrity status, and created a host of winners for those in the ecosystem, including the disruptors' employees and investors. As these disrupted businesses prioritized scaling up over profitability, consumers benefited as they received products and services, at bargain-basement prices, sometimes below cost. 

    The clearest loser from disruption is the status quo. As legacy companies melt down, in terms of profitability and value, the damage is felt in concentric circles, with employees facing wage cuts and job losses, and investors seeing write downs in their holdings  The peripheral damage is to the regulatory structures that govern these businesses, as the rule breakers became ascendant, leaving rule makers impotent and often on the side lines. To the extent that these regulations and rules were designed to protect the environment and the public, there are side costs for society as well.

    In short, disruption may have been a net positive for society, but there are casualties on its battlefield. In the battle for the global economic pie, the fact that so much of the disruption has originated in the United States, aided both by access to a capital and a greater tolerance for rule-breaking, has helped the United States maintain and even grow its share of global GDP. In practical terms, this has manifested in the soaring market capitalizations of the biggest technology companies, and it is their presence that has allowed the United States to ward off the decline in economic power and market cap that you have seen in much of the rest of the developed world.

Disruption goes macro

        For much of its history, disruption has been restricted to the business space and it has had only limited success when directed at systemic inefficiencies in less business-driven settings. Health care clearly meets all of the criteria for a good disruption target, consuming 20% of US GDP, with a host of unhappy constituencies (doctors, patients, hospitals and payers). However, attempts at disruption, whether it be from Mark Cuban’s pharmaceutical start-up or from Google and Amazon’s health care endeavors, have largely left the system intact. I have described education, at the school and college level, as deserving of disruption for more than two decades, but notwithstanding tries at online education, not much has changed at universities (yet).

    Can entire governments be disrupted? After all, it is hard to find anyone who would describe government organizations and systems as efficient, and the list of unhappy players is a mile long. The pioneers of government disruption have been in Latin America, with El Salvador and Argentina being their venues. Nayib Bukele, in El Salvador, and Javier Milei, in Argentina, have not just pushed back against the norms, but have reveled in doing so, and they were undoubtedly aided by the fact that the governments in both countries were so broken that many of their citizenry viewed any change as improvement. As we watch Elon Musk and DOGE move at hyper speed (by government standards), break age-old systems and push rules and laws to breaking point, I see the disruption playbook at play, and I am torn between two opposing perspectives. On the one hand, it is clear the US government has been broken for decades and tinkering at its edges (which is what every administration has done for the last forty years) has accomplished little to reduce the dysfunctionality of the system (and the deficits and debt that it creates). On the other, though, disrupting the US government is not the same as disrupting a business, since there are millions of vulnerable people (social security, Medicare and veteran care) whose lives rest on government checks, and a break in that process that is not fixed quickly could be catastrophic. There is a middle ground here, and unless DOGE finds it quickly, this disruption story will have lots of casualties.

Market and Micro Effects

    As I have wrestled with the barrage of news stories in the last few weeks, many with large consequences for economies and markets, I keep going back to what this means for my micro pursuits, i.e., analyzing how companies make decisions on investing, financing and dividends and what the values of these companies are. It is still early in that process, and there is much that I still don’t know the answer to, but here the ways I see this playing out.

In markets

    There are two key inputs that are market-driven which affect the values of every company. The first is interest rates, across the maturity spectrum, since their gyrations will play out across the market. In the graph below, I look at US treasury rates and how they have moved since the Trump election in early November:

The ten-year US treasury rate has declined from 4.55% on Election Day (November 5)  to 4.27% on March 13, 2025, but since that treasury rate is driven of expectations about inflation and real economic growth, Trump supporters will attribute the decline to markets anticipating a drop in inflation in a Trump administration and Trump critics suggesting that the rate drop is an indicator of a slowing  economy and perhaps even a recession. The yield curve has flattened out, with the 10-year rate staying higher than the 2-year rate, pushing that very flawed signal of economic recession into neutral territory. 

    The other number that I track is the equity risk premium, which at least in my telling, is a forward-looking number backed out of the market and the receptacle for the greed and fear in markets.  In the table below, I show my estimates of the implied equity risk premium for the S&P 500 at the start of every month, since January 2024, and on March 14, 2025.

The equity risk premium at the start of March was at 4.35%, surprisingly close to the 4.28% on Election Day, but that number has jumped to 4.68% in the first two weeks of March, indicating that uncertainty about tariffs and the economy is undercutting the resilience that the market has shown so far this year. In my view, the pathway that the equity risk premium takes for the rest of the year will be the key driver in whether equities level off, continue to decline or make a comeback. If equity risk premiums continue to march upwards, driven by increased uncertainty and the potential for trade wars, stock prices will drop, even if the economy escapes a recession, and adding a recession, with the damage it will create to expected earnings, will only make it worse. In one of the first posts I wrote this year, I looked at US equities, and valued the S&P 500 at 5262, putting it about 12% below the index level (5882) at the start of the year. Even with the drawdown in prices that we have seen through March 10, the index remains above my estimated value, and while that value reflected what I saw at the start of the year, what has happened in the last few weeks has lowered the fair value, not raised it.

In companies

    Changes in interest rates and risk premiums will affect the valuations of all companies, but assuming that the tariff announcements and government spending cuts will play out over the foreseeable future, there will be disparate effects across companies. I will draw on a familiar structure, where I trace the value of a company to its key drivers:

By narrowing our focus to the drivers of value, we can look at how company exposure to trade wars and DOGE will play out:

1. Revenue growth: On the revenue growth front, companies that derive most or all of their revenues domestically will benefit and companies that are dependent on foreign sales will be hurt by tariff wars. To assess how that exposure varies across sectors, I look at the percentage of revenues s in each  sector that companies in the S&P 500 get from foreign markets:

Based on revenues in 2023

Collectively, about 28% of the revenues, in 2023, of the companies in the S&P 500 came from foreign markets, but technology companies are most exposed (with 59% of revenues coming from outside the country) and utilities least exposed (just 2%)  to foreign revenue exposure. It is also worth noting that the larger market cap companies of the S&P 500 have a higher foreign market revenue exposure than smaller market cap companies. On the DOGE front, the attempts to cut costs are likely tol hit healthy care and defense, the two businesses that are most dependent on the government spending, most directly, with green energy, a more recent entrant into the government spending sweepstakes, also on the cutting block.

2. Operating  margins: A company that gets all of its revenues from the domestic markets can still be exposed to trade wars, if its production or supply chains is set in other countries. The data on this front is far less visible or reported than revenue data and will require more company-level research. It is also likely that if the attempts to bring production back to the United States come to fruition, wages for US workers will increase, at least in the longer term, pushing up costs for companies. In short, a tariff war  will lower the operating margins for many firms, with the size of the decline depending on their revenues, 

3. Reinvestment: To the extent that companies are altering their decisions on where to build their next manufacturing facilities, as a result of tariff fears or in hope of government largesse, there should be an effect on reinvest, with an increase in reinvestment (lower sales to capital ratios) at businesses where this move will create investment costs. Looking across businesses, this effect is likely to be more intense at manufacturing companies, where moving production is more expensive and difficult to do, that at technology or service firms.

4. Failure risk: Since 2008, the US government has implicitly, if not explicitly, made clear its preference for stepping in to help firms from failing, especially if they were larger and the cost of failure was perceived as high. It is not clear what the Trump administration's views are on bailing out companies in trouble, but may initial read is that government is less likely to jump in as a capital provider of last resort. 

    There is another way in which you can reframe how the shifts in politics and economics will play out in valuation. I have long argued that every valuation is a bridge between stories and numbers, and that to value a company, you have a start with a business story for the company, check to make sure that it is possible, plausible and probable, and connect the story to valuation inputs (revenue growth, margins, reinvestment and risk). Staying with that structure, I have also posited that the value of a company can sometimes be affected by its political connections or by the government acting as an ally or an adversary, making the government a key player in the company's story. While that feature is not uncommon in many emerging market companies, when analyzing US and European companies, we had the luxury, historically, of keeping governments out of company stories, other than in their roles of tax collectors and regulators. That time may well have passed, and it is entirely possible that when valuing US companies now, you have to bring the government into the story, and in some cases, a company's political connections can make or break the story.  

  The company where you are seeing the interplay between economics and politics play out most visibly right now is Tesla, a company that has had a rollercoaster history with the market. In 2024, its stock soared, especially so after the election, but it has now given up almost of its gains, almost entirely because of its (or more precisely, Elon Musk's) political connections. I revisited my Tesla valuation from January 2024, when I valued the stock at $182, triggering a buy in my portfolio when the stock price dropped to $170. In the intervening year, there were three developments that have affected the Tesla narrative:

1. A rethiinking the "electric cars are inevitable" story: For the last few years, it has become conventional wisdom that electric cars will eventually displace gas cars, and the question has been more about when that would happen, rather than whether. In 2024, you saw second thoughts on that narrative, as hybrids made a comeback, and the environmental consequences of having millions of electric cars on the road came into focus. To the extent that Tesla's value has come from an assumption that the electric car market will be huge, this affects end revenues and value.
2. The rise of BYD as a competitor for electric cars: Since its founding, Tesla has dominated the electric car business, and legacy car makers have struggled to keep up with it. in 2024, BYD, the Chinese electric car company, sold more electric cars than Tesla for the first time in history, and it is clearly beating Tesla not just in China, but in most Asian markets and even in Europe, with lower prices and more choices. Put simply, it feels like Tesla has its first real competitor in the electric car business.
3. The politicization of the Tesla story: There has been a backlash building from those who do not like Musk's political stances and it is spilling over into Tesla's sales, in Europe and the United States. As long as Musk remains at the center of the news cycle, this is likely to continue, and there is the added concern, even for Tesla shareholders who agree with Musk's politics, that he is too distracted now to provide direction to the company. 

These developments have made me more wary than I was last year on the end game for Tesla. While I do believe that Tesla will be one of the lead players in the electric car market, the pathway to a dominant market share of the electric car market has become rockier, and it seems likely that the electric car market will bifurcate into a lower-priced and a premium market, with BYD leading in the first (lower priced) market, especially in much of Asia, and Tesla holding its own in the premium car market, with a clear advantage in the United States. I remain skeptical that any of the legacy auto companies, notwithstanding the money that they have spend on electric cars and the quality of these cars, will challenge the newcomers on this turf. My updated valuation for Tesla is below:

Download Tesla valuation (March 2025)

My estimate of value for Tesla stands at about $150 a share, about $30 less than my value last year, and about $70 below its stock price. As an investor, I have been wary of taking a position in BYD, because of its Chinese origins and the presence of Beijing as a player in its story, but given that Tesla is now a political play, it may be time to open the door to the BYD investment, but that will have to wait for another post.

The Bottom Line

    While it is easy to blame market uncertainty on Trump, tariffs and trade wars for the moment, the truth is that the forces that have led us here have been building for years, both in our political and economic arenas. In short, even if the tariffs cease to be front page news, and the fears of an immediate trade war ease, the underlying forces of anti-globalization that gave rise to them will continue to play out in global commerce and markets. For investors, that will require a shift away from the large cap technology companies that have been the market leaders in the last two decades back to smaller cap companies with a more domestic focus. It will also require an acceptance of the reality that politics and macroeconomic factors will play a larger role in your company assessments, and create a bigger wild card on whether investments in these companies will pay off.

YouTube Video

Links

1. Valuation of Tesla in March 2025

Data Update 9 for 2025: Dividends and Buybacks - Inertia and Me-tooism!

In my ninth (and last) data post for 2025, I look at cash returned by businesses across the world, looking at both the magnitude and the form of that return. I start with a framework for thinking about how much cash a business can return to its owners, and then argue that, in the real world, this decision is skewed by inertia and me-tooism. I also look at a clear and discernible shift away from dividends to stock buybacks, especially in the US, and examine both good and bad reasons for this shift. After reporting on the total cash returned during the year, by public companies, in the form of dividends and buybacks, I scale the cash returned to earnings (payout ratios) and to market cap (yield) and present the cross sectional distribution of both statistics across global companies.

The Cash Return Decision

    The decision of whether to return cash, and how much to return, should, at least in principle, be the simplest of the three corporate finance decisions, since it does not involve the estimation uncertainties that go with investment decisions and the angst of trading of tax benefits against default risk implicit in financing decisions. In practice, though, there is probably more dysfunctionality in the cash return decision, than the other two, partly driven by deeply held, and often misguided views, of what returning cash to shareholders does or does not do to a business, and partly by the psychology that returning cash to shareholders is an admission that a company's growth days are numbered. In this section, I will start with a utopian vision, where I examine how cash return decisions should play out in a business and follow up with the reality, where bad dividend/cash return decisions can drive a business over a cliff. 

The Utopian Version

    If, as I asserted in an earlier post, equity investors have a claim the cash flows left over after all needs (from taxes to debt payments to reinvestment needs) are met, dividends should represent the end effect of all of those choices. In fact, in the utopian world where dividends are residual cash flows, here is the sequence you should expect to see at businesses:

In a residual dividend version of the world, companies will start with their cash flows from operations, supplement them with the debt that they think is right for them, invest that cash in good projects and the cash that is left over after all these needs have been met is available for cash return. Some of that cash will be held back in the company as a cash balance, but the balance can be returned either as dividends or in buybacks. If companies following this sequence to determine, here are the implications:

• The cash returned should not only vary from year to year, with more (less) cash available for return in good (bad) years), but also across firms, as firms that struggle on profitability or have large reinvestment needs might find that not only do they not have any cash to return, but that they might have to raise fresh capital from equity investors to keep going. 
• It also follows that the investment, financing, and dividend decisions, at most firms, are interconnected, since for any given set of investments, borrowing more money will free up more cash flows to return to shareholders, and for any given financing, investing more back into the business will leave less in returnable cash flows. 

    Seen through this structure, you can compute potential dividends simply by looking for each of the cash flow elements along the way, starting with an add back of depreciation and non-cash charges to net income, and then netting out investment needs (capital expenditures, working capital, acquisitions) as well as cash flow from debt (new debt) and to debt (principal repayments). 

While this measure of potential dividend has a fanciful name (free cash flow to equity), it is not only just a measure of cash left in the till at the end of the year, after all cash needs have been met, but one that is easy to compute, since every items on the list above should be in the statement of cash flows.

    As with almost every other aspect of corporate finance, a company's capacity to return cash, i.e., pay potential dividends will vary as it moves through the corporate life cycle, and the graph below traces the path:

There are no surprises here, but it does illustrate how a business transitions from being a young company with negative free cash flows to equity (and thus dependent on equity issuances) to stay alive to one that has the capacity to start returning cash as it moves through the growth cycle before becoming a cash cow in maturity.

The Dysfunctional Version

    In practice, though, there is no other aspect of corporate finance that is more dysfunctional than the cash return or dividend decision, partly because the latter (dividends) has acquired characteristics that get in the way of adopting a rational policy. In the early years of equity markets, in the late 1800s,  companies wooed investors who were used to investing in bonds with fixed coupons, by promising them predictable dividends as an alternative to the coupons. That practice has become embedded into companies, and dividends continue to be sticky, as can be seen by the number of companies that do not change dividends each year in the graph below:

While this graph is only of US companies, companies around the world have adopted variants of this sticky dividend policy, with the stickiness in absolute dividends (per share) in much of the world, and in payout ratios in Latin America. Put simply, at most companies, dividends this year will be equal to dividends last year, and if there is a change, it is more likely to be an increase than a decrease.

    This stickiness in dividends has created several consequences for firms. First, firms are cautious in initiating dividends, doing so only when they feel secure in their capacity to keep generate earnings. Second, since the punishment for deviating from stickiness is far worse, when you cut dividends, far more firms increase dividends than decrease them. Finally, there are companies that start paying sizable dividends, find their businesses deteriorate under them and cannot bring themselves to cut dividends. For these firms, dividends become the driving force, determining financing and investment decisions, rather than being determined by them.

This is, of course, dangerous to firm health, but given a choice between the pain of announcing a dividend suspension (or cut) and being punished by the market and covering up operating problems by continuing to pay dividends, many managers choose the latter, laying th e pathway to dividend madness.

Dividends versus Buybacks

     As for the choice of how to return that cash, i.e., whether to pay dividends or buy back stock, the basics are simple. Both actions (dividends and buybacks) have exactly the same effect on a company’s business picture, reducing the cash held by the business and the equity (book and market) in the business. It is true that the investors who receive these cash flows may face different tax consequences and that while neither action can create value, buybacks have the potential to transfer wealth from one group of shareholders (either the ones that sell back or the ones who hold on) to the other, if the buyback price is set too low or too high.    

    It is undeniable that companies, especially in the United States, have shifted away from a policy of returning cash almost entirely in dividends until the early 1980s to one where the bulk of the cash is returned in buybacks. In the chart below, I show this shift by looking at the aggregated dividends and buybacks across S&P 500 companies from the mid-1980s to 2024:

While there are a number of reasons that you can point to for this shift, including tax benefits to investors, the rise of management options and shifting tastes among institutional investors, the primary reason, in my view, is that sticky dividends have outlived their usefulness, in a business age, where fewer and fewer companies feel secure about their earning power. Buybacks, in effect, are flexible dividends, since companies, when faced with headwinds, quickly reduce or cancel buybacks, while continuing to pay dividends: In the table below, I look at the differences between dividends and buybacks:

If earnings variability and unpredictability explains the shifting away from dividends, it stands to reason that this will not just be a US phenomenon, and that you will see buybacks increase across the world. In the next section, we will see if this is happening.

    There are so many misconceptions about buybacks that I did write a piece that looks in detail at those reasons. I do want to reemphasize one of the delusions that both buyback supporters and opponents use, i.e., that buybacks create or destroy value. Thus, buyback supporters argue that a company that is buying back its own shares at a price lower than its underlying value, is effectively taking an investment with a positive net present value, and is thus creating value. That is not true, since that action just transfers value from shareholders who sell back (at the too low a price) to the shareholders who hold on to their shares. Similarly, buyback opponents note that many companies buy back their shares, when their stock prices hit new highs, and thus risk paying too high a price, relative to value, thus destroying value. This too is false, since paying too much for shares also is a wealth transfer, this time from those who remain shareholders in the firm to those who sell back their shares. 

Cash Return in 2024

    Given the push and pull between dividends as a residual cash flow, and the dysfunctional factors that cause companies to deviate from this end game, it is worth examining how much companies did return to their shareholders in 2024, across sectors and regions, to see which forces wins out.

Cash Return in 2024

    Let's start with the headline numbers. In 2024, companies across the globe returned $4.09 trillion in cash to their shareholders, with $2.56 trillion in dividends and $1.53 trillion taking the form of stock buybacks. If you are wondering how the market can withstand this much cash being withdrawn, it is worth emphasizing an obvious, but oft overlooked fact, which is that the bulk of this cash found its way back into the market, albeit into other companies. In fact, a healthy market is built on cash being returned by some businesses (older, lower growth) and being plowed back into growth businesses that need that capital.

    That lead in should be considered when you look at cash returned by companies, broken down by sector, in the table below, with the numbers reported both in US dollars and scaled to the earnings at these companies:

To make the assessment, I first classified firms into money making and money losing, and aggregated the dividends and buybacks for each group, within each sector.  Not surprisingly, the bulk of the cash bering returned is from money making firms, but the percentages of firms that are money making does vary widely across sectors. Utilities and financials have the highest percentage of money makers on the list, and financial service firms were the largest dividend payers, paying $620.3 billion in dividends in 2024, followed by energy ($346.2 billion) and industrial ($305.3 billion). Scaled to net income, dividend payout ratios were highest in the energy sector and technology companies had the lowest payout ratios. Technology companies, with $280.4 billion, led the sectors in buybacks, and almost 58% of the cash returned at money making companies in the sector took that form. 

   Breaking down global companies by region gives us a measure of variation on cash return across the world, both in magnitude and in the type of cash return:

It should come as no surprise that the United States accounted for a large segment (more than $1.5 trillion) of cash returned by all companies, driven partly by a mature economy and partly by a more activist investor base, and that a preponderance of this cash (almost 60%) takes the form of buybacks. Indian companies return the lowest percentage (31.1%) of their earnings as cash to shareholders, with the benign explanation being that they are reinvesting for growth and the not-so-benign reason being poor corporate governance. After all, in publicly traded companies, managers have the discretion to decide how much cash to return to shareholders, and in the absence of shareholder pressure, they, not surprisingly, hold on to cash, even if they do not have no need for it. It is also interesting that buybacks seems to be making inroads in other paths of the world, with even Chinese companies joining the party.

FCFE and Cash Return

    While it is conventional practice to scale dividends to net income, to arrive at payout ratios, we did note, in the earlier section, that you can compute potential dividends from financial statements, Here again, I will start with the headline numbers again. In 2024, companies around the world collectively generated $1.66 trillion in free cash flows to equity:

As you can see in the figure, companies started with net income of $6,324 billion, reinvested $4,582 billion in capital expenditures and debt repayments exceeded debt issuances by $90 billion to arrive at the free cash flow to equity of $1.66 trillion. That said, companies managed to pay out $2,555 billion in dividends and bought back $1,525 billion in stock, a total cash return of almost $4.1 trillion.

    As the aggregate numbers indicate, there are many companies with cash return that does not sync with potential dividends or earnings. In the picture below, we highlight four groups of companies, with the first two focused on dividends, relative to earnings, and the other two structured around cash returned relative to free cash flows to equity, where we look at mismatches.

Let's start with the net income/dividend match up. Across every region of the world, 17.5% of money losing companies continue to pay dividends, just as 31% of money-making companies choose not to pay dividends. Using the free cash flows to equity to divide companies, 38% of companies with positive FCFE choose not to return any cash to their shareholder while 48% of firms with negative FCFE continue to pay dividends. While all of these firms claim to have good reasons for their choices, and I have listed some of them, dividend dysfunction is alive and well in the data.

    I argued earlier in this post that cash return policy varies as companies go through the life cycle, and to see if that holds, we broke down global companies into deciles, based upon corporate age, from youngest to oldest, and looked at the prevalence of dividends and buybacks in each group:

As you can see, a far higher percent of the youngest companies are money-losing and have negative FCFE, and it is thus not surprising that they have the lowest percentage of firms that pay dividends or buy back stock. As companies age, the likelihood of positive earnings and cash flows increases, as does the likelihood of dividend payments and stock buybacks.

Conclusion

    While dividends are often described as residual cash flows, they have evolved over time to take on a more weighty meaning, and many companies have adopted dividend policies that are at odds with their capacity to return cash. There are two forces that feed this dividend dysfunction. The first is inertia, where once a company initiates a dividend policy, it is reluctant to back away from it, even though circumstances change. The second is me-tooism, where companies adopt cash return policies to match  their peer groups, paying dividends because other companies are also paying dividends, or buying back stock for the same reasons. These factors explain so much of what we see in companies and markets, but they are particularly effective in explaining the current cash return policies of companies.

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Data Updates for 2025

1. Data Update 1 for 2025: The Draw (and Danger) of Data!
2. Data Update 2 for 2025: The Party continued for US Equities
3. Data Update 3 for 2025: The times they are a'changin'!
4. Data Update 4 for 2025: Interest Rates, Inflation and Central Banks!
5. Data Update 5 for 2025: It's a small world, after all!
6. Data Update 6 for 2025: From Macro to Micro - The Hurdle Rate Question!
7. Data Update 7 for 2025: The End Game in Business!
8. Data Update 8 for 2025: Debt, Taxes and Default - An Unholy Trifecta!
9. Data Update 9 for 2025: Dividend Policy - Inertia and Me-tooism Rule!

Data Links

1. Dividend fundamentals, by industry (US, Global, Emerging Markets, Europe, Japan, India, China)
2. Cash return and FCFE, by industry (US, Global, Emerging Markets, Europe, Japan, India, China)

Data Update 8 for 2025: Debt, Taxes and Default - An Unholy Trifecta!

    There is a reason that every religion inveighs against borrowing money, driven by a history of people and businesses, borrowing too much and then paying the price, but a special vitriol is reserved for the lenders, not the borrowers, for encouraging this behavior. At the same time, in much of the word, governments have encouraged the use of debt, by providing tax benefits to businesses (and individuals) who borrow money. In this post, I look at the use of debt by businesses, around the globe, chronicling both the magnitude of borrowing, and the details of debt (in terms of maturity, fixed vs floating, straight vs convertible). The tension between borrowing too little, and leaving tax benefits on the table, and borrowing too much, and exposing yourself to default risk, is felt at every business, but the choice of how much to borrow is often driven by a range of other considerations, some of which are illusory, and some reflecting the frictions of the market in which a business operates.

The Debt Trade off

    As a prelude to examining the debt and equity tradeoff, it is best to first nail down what distinguishes the two sources of capital. There are many who trust accountants to do this for them, using whatever is listed as debt on the balance sheet as debt, but that can be a mistake, since accounting has been guilty of mis-categorizing and missing key parts of debt. To me, the key distinction between debt and equity lies in the nature of the claims that its holders have on cash flows from the business. Debt entitles its holders to contractual claims on cash flows, with interest and principal payments being the most common forms, whereas equity gives its holders a claim on whatever is left over (residual claims). The latter (equity investors) take the lead in how the business is run, by getting a say in choosing who manages the business and how it is run, while lenders act, for the most part, as a restraining influence.

Using this distinction, all interest-bearing debt, short term and long term, clears meets the criteria for debt, but for almost a century, leases, which also clearly meet the criteria (contractually set, limited role in management) of debt, were left off the books by accountants. It was only in 2019 that the accounting rule-writers (IFRS and GAAP) finally did the right thing, albeit with a myriad of rules and exceptions. 

    Every business, small or large, private or public and anywhere in the world, faces a question of whether to borrow money, and if so, how much, and in many businesses, that choice is driven by illusory benefits and costs. Under the illusory benefits of debt, I would include the following:

1. Borrowing increases the return on equity, and is thus good: Having spent much of the last few decades in New York, I have had my share of interactions with real estate developers and private equity investors, who are active and heavy users of debt in funding their deals. One reason that I have heard from some of them is that using debt allows them to earn higher returns on equity, and that it is therefore a better funding source than equity. The first part of the statement, i.e., that borrowing money increases the expected return on equity in an investment, is true, for the most part, since you have to contribute less equity to get the deal done, and the net income you generate, even after interest payments, will be a higher percentage of the equity invested. It is the second part of the statement that I would take issue with, since the higher return on equity, that comes with more debt, will be accompanied by a higher cost of equity, because of the use of that debt. In short, I would be very skeptical of any analysis that claims to turn a neutral or bad project, funded entirely with equity, into a good one, with the use of debt, especially when tax benefits are kept out of the analysis.
2. The cost of debt is lower than the cost of equity: If you review my sixth data update on hurdle rates, and go through my cost of capital calculation, there is one inescapable conclusion. At every level of debt, the cost of equity is generally much higher than the cost of debt for a simple reason. As the last claimants in line, equity investors have to demand a higher expected return than lenders to break even. That leads some to conclude, wrongly, that debt is cheaper than equity and more debt will lower the cost of capital. (I will explain why later in the post.)

Under the illusory costs of debt, here are some that come to mind:

1. Debt will reduce profits (net income): On an absolute basis, a business will become less profitable, if profits are defined as net income, if it borrows more money. That additional debt will give rise to interest expenses and lower net income. The problem with using this rationale for not borrowing money is that it misses the other side of debt usage, where using more debt reduces the equity that you will have to invest.
2. Debt will lower bond ratings: For companies that have bond ratings, many decisions that relate to use of debt will take into account what that added debt will do to the company’s rating. When companies borrow more money, it may seem obvious that default risk has increased and that ratings should drop, because that debt comes with contractual commitments. However, remember that the added debt is going into investments (projects, joint ventures, acquisitions), and these investments will generate earnings and cash flows. When the debt is within reasonable bounds (scaling up with the company), a company can borrow money, and not lower its ratings. Even if bond ratings drop, a business may be worth more, at that lower rating, if the tax benefits from the debt offset the higher default risk.
3. Equity is cheaper than debt: There are businesspeople (including some CFOs) who argue that debt is cheaper than equity, basing that conclusion on a comparison of the explicit costs associated with each – interest payments on debt and dividends on equity. By that measure, equity is free at companies that pay no dividends, an absurd conclusion, since investors in equity anticipate and build in an expectation of price appreciation. Equity has a cost, with the expected price appreciation being implicit, but it is more expensive than debt.

The picture below captures these illusory benefits and costs:

If the above listed are illusory reasons for borrowing or not borrowing, what are the real reasons for companies borrowing money or not borrowing? The two primary benefits of borrowing are listed below:

• Tax Benefits of Debt: The interest expenses that you have on debt are tax deductible in much of the world, and that allows companies that borrow money to effectively lower their cost of borrowing: 

    After-tax cost of debt = Interest rate on debt (1 – tax rate) 

In dollar terms, the effect is similar; a firm with a 25% tax rate and $100 million in interest expenses will get a tax benefit of $25 million, from that payment.  

• Debt as a disciplinary mechanism: In some businesses, especially mature ones with lots of earnings and cash flows, managers can become sloppy in capital allocation and investment decisions, since their mistakes can be covered up by the substantial earnings. Forcing these companies to borrow money, can make managers more disciplined in project choices, since poor projects can trigger default (and pain for managers).

These have to be weighted off against two key costs:

1. Expected bankruptcy costs: As companies borrow money, the probability that they will be unable to make their contractual payments on debt will always increase, albeit at very different rtes across companies, and across time, and the expected bankruptcy cost is the product of this probability of default and the cost of bankruptcy, including both direct costs (legal and deadweight) and indirect costs (arising from the perception that the business is in trouble).
2. Agency costs: Equity investors and lenders both provide capital to the business, but the nature of their claims (contractual and fixed for debt versus residual for equity) creates very different incentives for the two groups. In short, what equity investors do in their best interests (taking risky projects, borrow more money or pay dividends) may make lenders worse off. As a consequence, when lending money, lenders write in covenants and restrictions on the borrowing businesses, and those constraints will cause costs (ranging from legal and monitoring costs to investments left untaken).

The real trade off on debt is summarized in the picture below:

While the choices that businesses make on debt and equity should be structured around expected tax benefits (debt’s biggest plus) and expected bankruptcy costs (debt’s biggest minus), businesses around the world are affected by frictions, some imposed by the markets that they operate in, and some self-imposed. The biggest frictional reasons for borrowing are listed below:

1. Bankruptcy protections (from courts and governments): If governments or courts step in to protect borrowers, the former with bailouts, and the latter with judgments that consistently favor borrowers, they are nullifying the effect of expected bankruptcy costs in restraining companies from borrowing too much. Consequently, companies in these environments will borrow much more than they should.
2. Subsidized Debt: If lenders or governments lend money to firms at below-market reasons for reasons of virtue (green bonds and lending) or for political/economic reasons (governments lending to companies that choose to keep their manufacturing within the domestic economy), it is likely that companies will borrow much more than they would have without these debt subsidies.
3. Corporate control: There are companies that choose to borrow money, even though debt may not be the right choice for them, because the inside investors in these companies (family groups, founders) do not want to raise fresh equity from the market, concerned that the new shares issued will reduce their power to control the firm. 

The biggest frictional reasons for holding back on borrowing include:

1. Debt covenants: To the extent that debt comes with restrictions, a market where lender restrictions are more onerous in terms of the limits that they put on what borrowers can or cannot do will lead to a subset of companies that value flexibility borrowing less.
2. Overpriced equity: To the extent that markets may become over exuberant about a company's prospects, and price its equity too highly, they also create incentives for these firms to overuse equity (and underutilize debt). 
3. Regulatory constraints: There are some businesses where governments and regulators may restrict how much companies operating in them can borrow, with some of these restrictions reflecting concerns about systemic costs from over leverage and others coming from non-economic sources (religious, political).

The debt equity trade off, in frictional terms, is in the picture below:

As you look through these trade offs, real or frictional, you are probably wondering how you would put them into practice, with a real company, when you are asked to estimate how much it should be borrow, with more specificity. That is where the cost of capital, the Swiss Army Knife of finance that I wrote about in my sixth data update update, comes into play as a debt optimizing tool. Since the cost of capital is the discount rate that you use to discount cash flows back to get to a value, a lower cost of capital, other things remaining equal, should yield a higher value, and minimizing the cost of capital should maximize firm. With this in place, the “optimal” debt mix of a business is the one that leads to the lowest cost of capital:

You will notice that as you borrow more money, replacing more expensive equity with cheaper debt, you are also increasing the costs of debt and equity, leading to a trade off that can sometimes lower the cost of capital and sometimes increase it. This process of optimizing the debt ratio to minimize the cost of capital is straight forward, and if you are interested, this spreadsheet will help you do this for any company.

Measuring the Debt Burden

    With that tradeoff in place, we are ready to examine how it played out in 2024, by looking at how much companies around the world borrowed to fund their operations. We can start with dollar value debt, with two broad measures – gross debt, representing all interest-bearing debt and lease debt, and net debt, which nets cash and marketable securities from gross debt. In 2024, here are the gross and net debt values for global companies, broken down by sector and sub-region:

The problem with dollar debt is that absolute values can be difficult to compare across sectors and markets with very different values, I will look at scaled versions of debt, first to total capital (debt plus equity) and then then to rough measures of cash flows (EBITDA) and earnings (EBIT). The picture below lists the scaled versions of debt:

1. Debt to Capital: The first measure of debt is as a proportion of total capital (debt plus equity), and it is this version that you use to compute the cost of capital. The ratio, though, can be very different when you use book values for debt and equity then when market values are used. The table below computes debt to capital ratios, in book and market terms, by sector and sub-region: 
   
   I would begin by separating the financial sector from the rest of the market, since debt to banks is raw material, not a source of capital. Breaking down the remaining sectors, real estate and utilities are the heaviest users of debt, and technology and health care the lightest. Across regions, and looking just at non-financial firms, the US has the highest debt ratio, in book value terms, but among the lowest in market value terms. Note that the divergence between book and market debt ratios in the last two columns varies widely across sectors and regions.
2. Debt to EBITDA: Since debt payments are contractually set, looking at how much debt is due relative to measure of operating cash flow making sense, and that ratio of debt to EBITDA provides a measure of that capacity, with higher (lower) numbers indicating more (less) financial strain from debt.
3. Interest coverage ratio: Interest expenses on debt are a portion of the contractual debt payments, but they represent the portion that is due on a periodic basis, and to measure that capacity, I look at how much a business generates as earnings before interest and taxes (operating income), relative to interest expenses. In the table below, I look at debt to EBITDA and interest coverage ratios, by region and sector: 
   
   The results in this table largely reaffirm our findings with the debt to capital ratio. Reda estate and utilities continue to look highly levered, and technology carries the least debt burden. Across regions, the debt burden in the US, stated as a multiple of EBITDA or looking at interest coverage ratios, puts it at or below the global averages, whereas China has the highest debt burden, relative to EBITDA.

The Drivers and Consequences of Debt

    As you look at differences in the use of debt across regions and sectors, it is worth examining how much of these differences can be explained by the core fundamentals that drive the debt choice – the tax benefits of debt and the bankruptcy cost. 

• The tax benefit of debt is the easier half of this equation, since it is directly affected by the marginal tax rate, with a higher marginal tax rate creating a greater tax benefit for debt, and a greater incentive to borrow more. Drawing on a database maintained by PWC that lists marginal tax rates by country, I create a heat map:

Download corporate tax rates, by country

The country with the biggest changes in corporate tax policy in the world, for much of the last decade, has been the United States, where the federal corporate tax rate, which at 35%, was one of the highest in the world prior to 2017, saw a drop to 21% in 2017, as part of the first Trump tax reform. With state and local taxes added on, the US, at the start of 2025, had a marginal corporate tax rate of 25%, almost perfectly in line with a global norm. The 2017 tax code, though, will sunset at the end of 2025, and corporate tax rates will revert to their old levels, but the Trump presidential win has not only increased the odds that the 2017 tax law changes will be extended for another decade, but opened up the possibility that corporate tax rates may decline further, at least for a subset of companies.

        An interesting question, largely unanswered or answered incompletely, is whether the US tax code change in 2017 changed how much US companies borrowed, since the lowering of tax rates should have lowered the tax benefits of borrowing. In the table below, I look at dollar debt due at US companies every year from 2015 to 2024, and the debt to EBITDA multiples each year:

As you can see, the tax reform act has had only a marginal effect on US corporate leverage, albeit in the right direction. While the dollar debt at US companies has continued to rise, even after marginal tax rates in the US declines, the scaled version of debt (debt to capital ratio and debt to EBITDA have both decreased).

• The most commonly used measure of default risk is corporate bond ratings, since ratings agencies respond (belatedly) to concerns about default risk by downgrading companies. The graph below, drawing on data from S&P< looks at the distribution of bond ratings, from S&P, of rated companies, across the globe, and in the table below, we look at the breakdown by sector: 
  

The ratings are intended to measure the likelihood of default, and it is instructive to look at actual default rates over time. In the graph below, we look at default rates in 2024, in a historical context:

S&P

As you can see in the graph, default rates are low in most periods, but, not surprisingly, spike during recessions and crises. With only 145 corporate defaults, 2024 was a relatively quiet year, since that number was slightly lower than the 153 defaults in 2023, and the default rate dropped slightly (from 3.6% to3.5%) during the year. 

The default spread is a price of risk in the bond market, and if you recall, I estimated the price of risk in equity markets, with an implied equity risk premium, in my second data update. To the extent that the price of risk in both the equity and debt markets are driven by the endless tussle between greed and fear, you would expect them to move together much of the time, and as you can see in the graph below, I look at the implied equity risk premium and the default spread on a Baa rated bond:

Damodaran.com

In 2024, the default spread for a Baa rated dropped from 1.61% to 1.42%, paralleling a similar drop in the implied equity risk premium from 4.60% to 4.33%. 

Debt Design

    There was a time when businesses did not have much choice, when it came to borrowing, and had to take whatever limited choices that banks offered. In the United States, corporate bond markets opened up choices for US companies, and in the last three decades, the rest of the world has started to get access to domestic bond markets. Since corporate bonds lend themselves better than bank loans to customization, it should come as no surprise now that many companies in the world have literally dozens of choices, in terms of maturity, coupon (fixed or floating), equity kickers (conversion options) and variants on what index the coupon payment is tied to. While these choices can be overwhelming for some companies, who then trust bankers to tell them what to do, the truth is that the first principles of debt design are simple. The best debt for a business is one that matches the assets it is being used to fund, with long term assets funded with long term debt, euro assets financed with euro debt, and with coupon payments tied to variables that also affect cash flows. 

There is data on debt design, though not all companies are as forthcoming about how their debt is structured. In the table below, I look at broad breakdowns – conventional and lease debt, long term and short debt, by sector and sub-region again:

The US leads the world in the use of lease debt and in corporate bonds, with higher percentages of total debt coming from those sources. However, floating rate debt is more widely used in emerging markets, where lenders, having been burned by high and volatile inflation, are more likely to tie lending rates to current conditions.

    While making assessments of debt mismatch requires more company-level analysis, I would not be surprised if inertia (sticking with the same type of debt that you have always uses) and outsourcing (where companies let bankers pick) has left many companies with debt that does not match their assets. These companies then have to go to derivatives markets and hedge that mismatch with futures and options, creating more costs for themselves, but fees and benefits again for those who sell these hedging products.

Bottom Line

    When interest rates in the United States and Europe rose strongly in 2022, from decade-long lows, there were two big questions about debt that loomed. The first was whether companies would pull back from borrowing, with the higher rates, leading to a drop in aggregate debt. The other was whether there would be a surge in default rates, as companies struggled to generate enough income to cover their higher interest expenses. While it is still early, the data in 2023 and 2024 provide tentative answers to these questions, with the findings that there has not been a noticeable decrease in debt levels, at least in the aggregate, and that while the number of defaults has increased, default rates remain below the highs that you see during recessions and crises. The key test for companies will remain the economy, and the question of whether firms have over borrowed will be a  global economic slowdown or recession.

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Data Updates for 2025

1. Data Update 1 for 2025: The Draw (and Danger) of Data!
2. Data Update 2 for 2025: The Party continued for US Equities
3. Data Update 3 for 2025: The times they are a'changin'!
4. Data Update 4 for 2025: Interest Rates, Inflation and Central Banks!
5. Data Update 5 for 2025: It's a small world, after all!
6. Data Update 6 for 2025: From Macro to Micro - The Hurdle Rate Question!
7. Data Update 7 for 2025: The End Game in Business!
8. Data Update 8 for 2025: Debt, Taxes and Default - An Unholy Trifecta!

Data Links

1. Debt fundamentals, by industry (US, Global, Emerging Markets, Europe, Japan, India & China)
2. Debt details, by industry (US, Global, Emerging Markets, Europe, Japan, India & China)