In the data update posts this year, I have wended my way from the macro (equities collectives, the bond market and other asset classes) to the micro, starting with hurdle rates and returns in posts five and six and the debt/equity choice in my seventh post. In this post, I will look at the decision by businesses on how much cash to return to their owners, and in what form (dividends or buybacks), and how that decision played out globally in 2025. I will argue that dividend policy, more than any other aspect of corporate finance, is dysfunctional both for the firms that choose to return the cash and the investors who receive that cash. It is also telling that there are many who seem to view the very act of returning cash as a sign of failure on the part of firms that do so, even though it is the end game for every successful business.
The Dividend Decision
I start my corporate finance classes with a description of three core decisions that every firm has to make in the course of business, starting with the investment decision, where you try to invest in projects and investments that earn more than your hurdle rate, moving on to the financing decision, where you decide on the mix of debt and equity to use in funding those investments, and ending with the dividend decision, where firms decide how much cash to return to their owners. In the case of privately owned businesses, this cash can be withdrawn by the owners from the business, but in publicly listed companies, it takes the form of dividends or buybacks. In keeping with the notion that these are the cashflows to equity investors, and that those cash flows should represent what is left after (residual) after all other needs have been met, dividends should reflect that status and, at least in principle, be set after investing and financing decisions have been made:
That utopian view of residual cash being returned to shareholders is put to the test by two real-world realities that often govern corporate dividend policy:
Inertia: In many companies, dividend policy is set on auto pilot, with dividends this year set equal to dividends in the last year. It is for that reason that the word I would use to describe dividend policy, at least when it comes to conventional dividends, is 'sticky', and you can can see that stickiness at play at US companies, if you track the percentage of companies that increase dividends, decrease dividends or leave them unchanged every year.
In every single year, from 1988 to 2025, the percentage of companies that pay the same dividends that they did in the previous year outnumbers companies that change dividends, and when dividends are changed, they are more likely to be increased than decreased.
Me-tooism: In most companies, managers look to peer group dividend policy for guidance on how much, if any, to pay in dividends. Thus, if you are a bank or a utility, it is likely that you will pay high dividends, because everyone else in the sector does so, whereas technology companies will pay no or low dividends, because that is industry practice. While there are good reasons why some industry groups pay more dividends than others, including more predictable earnings and lower growth (and investment needs), hewing to the peer group implies that there will be outliers in each group (fast-growing banks or a mature technology companies) that will be trapped into dividend policies that don't suit them.
When maintaining or increasing dividends become the end game for a business, you unleash dividend monsters, where investing and financing decisions are skewed to meet dividend needs. Thus, a firm may turn away good investments or borrow much more than it should because it feels the need to sustain dividends.
I have long argued that dividends, in their sticky form, are unsuitable as cash returns to shareholders, but for much of the last century, they remained the primary or often only way to return cash to shareholders. While buying back stock has always been an option available to US companies, its use as a systematic way of returning cash picked up in the 1980s, and in the years since, stock buybacks have become the dominant approach to returning cash for US companies:
As you can see, in the last decade, more than 60% of cash returned to shareholders took the form of buybacks. The primary reason, in my view, is that buybacks, unlike dividends, are flexible, with companies often reversing buybacks, if macro circumstances change, as was the case in 2008 and 2020. There are other reasons that have been offered for the explosive growth in buybacks, but none of them are as significant. There are some who have argued it is stock-based compensation for managers that is pushing them away from dividends to stock buybacks, but that rationale makes more sense for stock options, where stock prices mater, than for restricted stock. In fact, even as more companies shift to restricted stock as their stock compensation mechanism, buybacks have continued to climb, and they are just as high at companies that have no or very low stock based compensation as at companies with high stock-based compensation. Investor taxes are alway in the mix, since investors are often taxed at different rates on dividends and capital gains, but changes in tax law in the last two decades have reduced, if not eliminated, the tax disadvantages associated with dividends, cutting against this argument.
I know that there are many investors, especially in the value investing camp, and quite a few economists, who believe that the shift away from dividends to buybacks is unhealthy, albeit for different reasons. I will return to many of the myths that revolve around buybacks later in this post.
A Rational Cash Return Policy
If you were designing a sensible cash return policy, it has to start with an assessment of how much cash there is available for a firm to return. Since that "potential dividend" should be the cash left over after taxes are paid, reinvestment has been made and debt repaid, it can be computed fairly simply from the statement of cash flows, as free cashflow to equity:
Note that free cash flow to equity starts with equity earnings, converts those earnings to cash flows by adding back depreciation and other non-cash charges, and then netting out capital expenditures and changes in working capital, with increases (decreases) in working capital reducing (increasing) cash flows. It is completed by incorporating the cash flows from debt, with debt issuances representing cash inflows to equity investors and debt repayments becoming cash outflows. Can free cash flows to equity be negative? Absolutely, and it can happen either because you are a money-losing company, too deep in the hole to dig yourself out, or even a money-making companies, with large reinvestment needs? Obviously, paying out dividends or buying back stock when your free cash flows to equity is violating the simple rule that if you are in a hole, you need to stop digging.
If your free cash flow to equity is positive, you can choose to return it to shareholders, either in the form of dividends or buybacks, but you are not obligated to do so. In fact, if you have positive free cashflows to equity and you choose to return none or only a portion of that cash flow, the difference accumulates into a cash balance. If you choose to return more than your free cashflow to equity, you will either have to deplete an existing cash balance, or if you run out of cash, go out and raise fresh capital.
A company that systematically holds back on cash that it could have returned will, over time, accumulate a large cash balance, but that, by itself, may not trigger a shareholder response, if shareholders trust the company's managers with their cash. After all, cash invested in liquid and riskless investments, like treasury bills and commercial paper, is a neutral (zero NPV) investment, and leaves shareholders unaffected. If you don't trust management to be disciplined, though, you may punish a company for holding too much cash, effectively apply a "lack-of-trust" discount to the cash. The picture below provides a framework for thinking through the cash return decision, and how it will play out in markets.
As you look at the interplay between earnings, investment needs and potential dividends, you can already see why you should expect cash return policies to change over a company's life cycle:
The cash returns you see in this graph should largely map on to common sense, with start-ups and very young companies, often money-losing and requiring substantial reinvestment to grow, having negative free cash flow to equity (thus requiring equity infusions). Young growth companies are usually self-funding because internal cash flows may rise to cover reinvestment, but these cash flows are not enough to pay dividends. Mature growth companies have enough cash to return, but stick with buybacks, because they value flexibility. Mature stable companies represent the sweet spot for dividend paying, since they have little in reinvestment needs and large predictable earnings and cash flows. As with everything else in the aging process, companies that refuse to act their age, i.e., young companies that choose to pay dividends or buy back stock or mature companies that insist on holding on to cash, damage themselves and their shareholders.
Dividends in 2025
I will start the assessment of how much companies returned to shareholders in 2025 by looking at conventional dividends paid by companies, using two metrics. The first metric is the dividend payout ratio, where I divide dividends paid by net income, but only if net income is positive; if net income is negative, and dividends get paid, the payout ratio is not meaningful:
As you can see the median payout ratio is about 35% (59%) for US (global) companies, but in both samples, most companies do not pay dividends. There is a sizable subset of companies (12% of US and 14% of global companies) that pay out more than 100% of earnings as dividends, with multiple reasons for that oversized number including a bad earnings year, a desire to increase financial leverage and partial liquidation plans all coming into play.
The second metric is the dividend yield, computed by dividing dividends paid by market capitalization, or dividends per share by the market price per share. In the graph below, I look at the distribution of dividend yields across companies in the graph below, in 2025:
Again looking at only dividend paying firms in the US and global samples, the median dividend yield was 1.10% for the former and 2.43% for the latter, with major divergences across sub-regions; note that the percent of dividend paying firms in the United States has dropped below 30% and even globally, less than half of firms pay dividends. The dividend yield ties into the cost of equity discussion that I initiated in my fifth data update, where I described the cost of equity as the rate of return that investors expect to make on their equity investments. In the United States, for instance, that expected return was about 8.50% at the start of 2026, which would indicate that if you are an equity investor, it is price appreciation that you are dependent on, for the bulk of your equity return.
The dividend yield for equities has declined over time, with the drop off being most noticeable in the United States. The graph below looks at the dividend yield on the S&P 500 from 1960 to 2025, and how that number has become a smaller and smaller portion of the overall expected return on stocks (which I compute with the implied equity return approach):
In 1960, about half of your expected return on stocks came from dividends and that statistic has trended downwards for the last few decades, and in 2025, it represented less than 15% of the total return on stocks.
As a final part of this analysis, I looked at dividend yields and payout ratios, broken down by sector, for both US and global companies:
As you can see, the sectors with the highest percentage of firms paying dividends are financials, real estate and utilities, for both US and global companies, and consumer product companies join in that group, for global companies. In terms of payout ratios, the same three sectors dominate, with energy and real estate returning more than 200% of net income as dividends, in 2025, and posting dividend yields in excess of 6%. Technology companies and communication services have the lowest percent of dividend paying companies and the lowest dividend yields and payout ratios.
The drop in dividend yields over time for the market, the decline in dividend paying firms and the concentration of dividend paying firms in some sectors has put old time value investing to the test. Ben Graham's strategy of principal protection was built around buying large dividend paying firms and holding on for the long term and it has hit a wall. Any investing strategy built around dividends will result in a portfolio composed of mature and declining firms, and even if you accept that reality, those firms are increasingly concentrated in real estate, banking and utilities.
Buybacks - Myths and Realities
As buybacks have soared in the United States, misconceptions and myths about buybacks have also surged, with some myths used to back up the argument that buybacks are unhealthy and should therefore be banned and others presented as the basis for buybacks as good, representing cannot-lose strategies to beat the market. I will start with the myths that are used to argue against buybacks first, before moving on to those that are used to justify it:
1. Myths in favor of the argument that buybacks are bad and should be restricted or stopped
Myth 1.1: Buybacks are a US phenomenon
Reality 1.1: Buybacks are becoming a global phenomenon
When US firms first started buying back stock in the 1980s, it is true that is was almost entirely or primarily a phenomenon restricted to the US, with large parts of the world restricting or banning the use of buybacks to prevent price manipulation by companies. That is no longer the case, and companies around the world have taken to buybacks, as a flexible alternative to dividends, have adopted the practice. In 2025, I looked at dividends and buybacks from companies around the world:
Companies in the United States are still in the lead in the buyback race, buying back $1.153 trillion in stock in 2025, close to 60% of overall cash returned. Canada, the UK, and Japan are not far behind with more than 35% of cash returned taking the form of buybacks, and the EU and environs, often the slowest to adapt to change, saw almost 29% of cash returned in buybacks. For a variety of reasons, including poor corporate governance and regulatory restrictions, Africa & the Middle East, Eastern Europe and much of south and southeast Asia return relatively little in buybacks.
Myth 1.2: Buybacks are wasteful and reduce corporate investment
Reality 1.2: Buybacks redirect corporate investment from mature companies to growth businesses
The argument that buybacks are wasteful often come from using a firm as a self-contained economic unit, and noting that money used on buybacks cannot be reinvested back into the firm. That is absolutely true, but the cash that goes into buybacks goes to investors and mostly goes back into the market, as investments in other companies. While there are clearly exceptions, where companies that should be investing back into their businesses use that cash to buyback stock, the companies that are the biggest buyers of their own stock are mature firms with insufficient investment opportunities and the companies that have the cash redirected into them need that cash to fund their growth. You can see this play out, when you look at stock buybacks broken down, by age decile (based upon corporate age) for US and global companies:
As you can see, younger companies are not only less likely to buy back stock, but also return less cash in dividends and buybacks, at least as a percent of market capitalization than older companies. Using the life cycle perspective, this suggests that cash is rotating out of older, more mature businesses into younger businesses. I would argue that the difference between geographies where buybacks are rare and geographies where buybacks are common is not in how much corporate investment there is, but in where that investment is directed, with the former investing investing back into declining businesses and the latter funding higher growth and newer businesses.
Myth 1.3: Buybacks are funded with debt are are making companies too highly levered
Reality 1.3: Buybacks are primarily funded with free cash flows to equity and even as buybacks have surged, debt ratios have decreased.
I am not a great believer in case studies precisely because anecdotal evidence is spun into backing priors and preconception.s There are, of course, firms that have dug themselves into a hole by buying back immense amounts of stock, and funding those buybacks with debt, but the aggregate debt ratios for US non-financial service firms, with debt to capital ratios measured against both book and market, have declined over the last four decades, even as buybacks have surged.
If your response is that not all companies buy back stock, and that debt ratios has risen at companies that buy back stock, a comparison of debt ratios (debt to EBITDA and debt to capital) for US firms that bought back stock in 2025 versus those that do not dispels that argument:
If firms are borrowing money to fund buybacks, it is clearly not showing up in the statistics, since companies that bought back stock had much lower debt loads than the companies that did not, a simplistic comparison, but one that carries heft.
Myth 1.4: Buybacks are value-destroying because companies tend to buy back their own stock when prices are too high
Reality 1.4: Buybacks, at any price, can neither add nor destroy value. They can just transfer value
Warren Buffett was late to the buyback party, but when he initiated buybacks at Berkshire Hathaway, he introduced a constraint, which is that he would do buybacks only if he believed that the company's stock price was less than intrinsic value. He, of course, had the credibility to make this assertion, but most companies don't impose this constraint and there is evidence that they often buy back their shares when stock prices are higher than they are lower. That does seem like value destruction, but a cash return can neither add nor destroy value, but it can transfer wealth. In the case of stock buybacks at too high a price, wealth is transferred from those who remain loyal shareholders in the firm to those who sell their shares. While there is hand wringing about this, you have a choice, as a shareholder, in a buyback, to sell or hold on, and if you believe that the buyback is at too high a price, you should sell your shares back.
2. Myths in favor of the argument that buybacks are good and generate excess returns for investors
Myth 2.1: Buybacks are value-adding because companies that buy back their own stock when prices are lower than fair value are taking positive net present value investments.
Reality 2.1: Buybacks, at any price, can neither add nor destroy value. They can just transfer value.
This is the inverse of the argument that buybacks are value destroying and they are both grounded in a misclassification of buybacks as projects, rather than cash return, competing with investment projects for the company's dollars. The truth again is that a stock that buys back stock at lower than fair value is transferring wealth from those who sell back to those who remain, and here again, if you are on the wrong side of wealth transfer, it was your choice to sell back that made you the loser.
Myth 2.2: Buybacks are almost always good for stock prices, since there are fewer shares outstanding after buybacks, and that should increase the price per share.
Reality 2.2: A buyback can increase, do nothing or decrease value per share, depending on the price at which it is done and its effects on leverage.
Buybacks reduce share count (the denominator) but the cash that leaves the firm also reduces fir value (the numerator). A fair-value buyback will create offsetting effects, leaving value per share unchanged, though there can be a secondary effect on value, if the buyback, by reducing equity, changes the debt to capital mix and cost of capital for a company:
It is true that empirical evidence backs up the notion that stock prices benefit from buybacks, but that may be from the selection bias of under levered firms with large cash balances being the biggest players in the stock buyback game.
In general, almost all of these myths come out of treating buybacks as something new and different, rather than a variant on dividends. In general, companies that should not be paying dividends, either because they lack the cash or the future is uncertain, should not be buying back stock either.
Dividend Dysfunction
At the start of this post, I noted that dividend policy is dysfunctional at many firms, driven by inertia (we've always paid dividends or we've never paid dividend before) and the desire to hew to peer group policies. As a result, there are many companies around the world that adopt dividend policies that, at least of the face of it, take explaining including:
Money-losing companies that pay dividends: While there are some companies that offer justifications grounded in worries about sending bad signals or hopes of a bounce back in earnings, many get stuck with dividend policies, because of inertia or peer group pressure, that can drive them into ruin.
Money-making companies that refuse to pay dividends: Here again, there can be good reasons for holding back including concerns about whether you can sustain earning and expectations that you will need to invest more in the future, but in some cases, it can unwillingness to initiate dividends in an industry where no one else pays dividends.
Negative FCFE companies that return cash (dividends or buybacks): In addition to hopes for a bounce back in FCFE, companies may continue to return cash, even with negative FCFE, because they are trying to increase debt ratios or shrink their businesses over time.
Positive FCFE companies that return no cash: Companies that have positive FCFE that don't return cash may hold back that cash because of the desire to reduce debt ratios or because they ahve investment plans.
The graph below lists out the number of companies in each group, broken down by geography:
Across the globe in 2025, almost 18% of money-losing companies paid dividends, as did about 70% of money-making companies. With FCFE as your indicator, about 37% of companies that returned cash (in dividends and buybacks) in 2025, had negative FCFE, as did 66% of companies with positive FCFE.
Conclusion
There are a whole host of misalignments between what companies return to their shareholders, either as dividends or in buybacks, and what they can, as potential dividends. That suggests to me, and perhaps I am wrong, that investment strategies that are built around cash return, whether they be dividends or buybacks, are likely to go off the tracks. Furthermore, any strategy that is built entirely around dividends, as is the case with strategies where you load up on high dividend yield stocks or buy a handful of heavy dividend payers, such as the Dogs of the Dow, misses the essence of equity investing. A stock is not a bond, where dividends replace coupons, and you get some price appreciation on top, and treating it as such will only create disappointment.
In my fifth data update, I examined hurdle rates in 2025, and in my sixth data update, I looked at the profitability and return metrics for firms. Both hurdle rates and profitability metricsmcan be affected by how much debt companies choose to have in their financing structure, and it enters explicitly into my cost of capital calculations, both through the costs of equity/debt and the mix of the two, and into my accounting return calculations, for net margin and return on equity. In this session, I start with an examination of the trade off that all businesses face when it comes to choosing between debt and equity to fund their operations, and then look the debt choices that companies made in 2025. As with every other one of my data updates this year, AI enters this conversation not only because of the huge investments that are being made into AI architecture, but also because a non-trivial portion of this investment is coming from debt, with private credit as a key contributor.
Debt versus Equity: Choices and Tradeoff
The discussion of the tradeoffs that businesses face on whether to borrow money (debt) or use owner's funds (equity) has to start with a clear distinction between what it is that sets them apart. While that distinction may seem trivial, since accountants do break financing down into debt and equity on accounting balance sheets, accountants are not always consistent in their categorization, and I think that understanding what sets debt apart from equity can help catch these inconsistencies. There are three dimensions where debt and equity deviate:
Nature of claim: Debt gives its holders a contractual claim on the cash flows, insofar as the terms of interest and principal payments are laid down contractually at the time of the borrowing. Note that these contractual claims cover both fixed rate debt, where the interest payments are fixed over the lifetime of the debt, and floating rate debt, where the interest payments will change over time, but in ways that are specified by the bond/loan agreements. Equity gives its holders a residual claim, i.e,, a claim on cash flows, if any, that are left over after other claim holders have been paid.
Priority of claim: This follows from the first distinction, but debt holders get first claim on the cashflows, when the firm is in operation, and on liquidation proceeds, if the firm ever goes bankrupt. It is this priority of claims that should generally make debt safer than equity in almost every enterprise that employs both.
Legal consequences: A company that fails to pay dividends to its equity investors, no matter how deeply set their expectations of receiving these dividends, may see its stock price drop, but it cannot be held legally accountable for the failure. A company that fails to make its contractual obligations on debt can not only be sued, but can be pushed into bankruptcy, effectively ending its business life.
There are three other distinctions, which do not always hold, but are usually true:
Tax Treatment: In much of the world, the tax code is tilted in favor of debt, with interest payments being tax deductible and cash flows to equity (dividends or buybacks) coming out of after-tax cash flows, but there are three caveats. The first is that the tax savings from debt kick in only when a company is generating a taxable profit, though laws on tax loss carry-forwards can allow even money-losing firms to get tax benefits, albeit with a delay. The second is that there are parts of the world, such as the Middle East, where the tax code explicitly bars interest tax deductions, though companies find work arounds sometimes to get the benefits. The third is that there are a few countries that try to even the playing field by either giving a tax deduction to companies for some payments to equity investors (interest on capital as a tax deduction in Brazil) or to investors directly by allowing them credits for corporate taxes paid, when they receive dividends.
Role in management: In most businesses, equity investors are given supremacy when it comes to managing the company, exercising that power through either direct ownership or corporate governance mechanisms (such as boards of directors). Again, there are exceptions, as is the case where lenders are given seats on boards of directors or veto power over major operating decisions, but these exceptions are usually triggered when companies violate covenants in loan agreements.
Maturity: Debt usually has a finite maturity, though as we saw with the Google hundred-year bond issuance just a few weeks ago, that maturity may be well beyond the lifetime of the buyers of the bond. Equity, in contrast, is, at least on paper, an instrument with no finite due date, and may have cash flows that last into perpetuity.
The figure below captures the differences between debt and equity in the context of a financial balance sheet:
With these distinctions in place, and given that businesses have a choice of using either debt or equity to fund their operations, let us look at the trade off, starting with what the fictional (but often used) reasons for using one source of funding over the other:
One of the most common (bad) reasons that I hear business owners and CFOs of even large companies give for borrowing money is that debt is cheaper than equity. On the face of it, that is of course true, but it is an illusion, at least without the tax benefits kicking in. If the debt is fairly priced, i.e., you are being charged an interest rate that reflects your default risk, borrowing money will make your equity more risky and leave your cost of capital unchanged (if you have no default risk) or raise it (if you have default risk). Intuitively, your cost of capital is designed to capture the risk in your operations, and playing games on the financing side cannot change your operational risk. Among risk-takers, a common reason for using debt is that it will increase your return on equity, and while that again is technically true, it will also raise your cost of equity and magnify the impact of both your successes and your failures. Thus, if you want to borrow money to magnify the payoff to you, as an equity investor, from a successful trade or investment, you should do so, but dispense with the illusion that this is a free lunch. Those who avoid debt have their own share of illusions, starting with the argument that the interest payments on borrowed money will lower net income. That is true, but since you have less equity invested, you may still come out as a beneficiary. They also argue that debt will increase default risk, and lower their bond ratings, but of which are likely to happen, but the objective in business is not to maximize bond ratings, but to increase value; a BBB-rated firm that borrows money and gets tax advantages can be worth more than the same firm with a AAA rating and no debt.
So what are the real trade offs? The first and biggest benefit of debt is its tax treatment, with the tax benefits adding to firm value. Note, and this is said with no moral or ethical judgment attached to it, that this increase in value is coming from taxpayers and not from your operations becoming more valuable. A secondary benefit may come from imposing discipline on managers in public companies, with the need to make interest payments operating as a restraint on a headlong rush into poorly performing investments. On the other side of the ledger, the biggest concern you should have when you borrow money is that it increases the risk of bankruptcy, which if it happens, truncates business life, and even it does not, concerns about it happening can alter how customers, suppliers and investors interact with a business. The other cost that you face when you borrow money is that equity investors and lenders have very different interests, with equity seeking upside and lenders worrying about downside, and the costs of that conflict of interests plays out in covenants and restrictions on operating activity. The figure below summarizes these real trade offs.
The tax benefits versus bankruptcy cost trade off on debt is a simple and very powerful explainer of how much companies should borrow, but in the real world, there are companies that sometimes override the tradeoff and choose to borrow far more or far less than you would expect them to, and they are not necessarily being irrational. Here are three reasons why companies may choose a sub-optimal financing mix:
Shields against bankruptcy: If the biggest restraint on borrowing more is the fear of default, anything that reduces or eliminates that fear will cause companies to borrow more money. That default protection can come from governments acting as implicit or explicit guarantors of corporate debt, as was the case with Korean companies in the 1990s, or from seeing other companies in trouble being bailed out by the government, because they were too big to fail.
Control versus Value: While businesses have the option of using either equity or debt to fund operations, raising fresh equity usually requires giving up ownership of the business to venture capitalists (at a private business) or to other public market investors (for public companies). For founders and family groups that value control over almost everything else, this can result in firms borrowing money, even though the fundamentals do not support the action. This can explain why Middle Eastern firms, many of which get no tax benefit from debt, may choose to borrow money to fund operations, usually with higher costs of capital, as well as the existence of venture debt, an almost absurd notion from a corporate finance standpoint, since you are lending to start-ups and young money-losing companies with unformed business models and
Subsidized debt: If a business has access to debt with below-market interest rates, given default risk, it may make sense to borrow money at these subsidized rates. These debt subsidies are often granted to companies that are seen as delivering on a social purpose (green energy in the last decade) or a political/security interests (defense and infrastructure businesses), and you should therefore not be surprised if they all carry too much debt.
On the other side of the ledger, there are three reasons why companies may borrow less than they should:
Restrictive covenants: In markets where debt comes primarily from bankers, it is possible that the covenants that come with this debt are so onerous that businesses will choose to leave tax benefits on the table in order to preserve operating flexibility; this may explain why technology companies, even those with large and stable cash flows, often choose not to borrow money or if they have to, go directly to bond markets.
Overpriced equity: Financial markets make mistakes, and sometimes those mistakes may work in your favor as a company with your stock price soaring well above what you think is justifiable, given your fundamentals. In that case, you may choose to use equity, even if you have debt capacity, using your own overpriced shares as currency in funding acquisitions.
Regulatory constraints: In some countries and/or sectors, there may be regulatory restrictions on borrowing that cap how much debt you can take on, even though you have the capacity to carry more in debt. Those restrictions can take the form of limits on book debt ratios or on how much interest expense is tax deductible, as a function of revenues or EBITDA.
The picture below captures these frictional considerations:
In sum, the choices between debt and equity play out differently at different companies, depending not only on the characteristics of the company (tax rate, default risk etc.) but also on the management team making that decision on whether to borrow money. If you are an optimizer, by nature, you may this discussion too diffuse, since it points you in a direction (more or less debt) and not to a specific debt mix, but that is easily remedied, if you use the cost of capital as your optimizing tool to find the mix of debt and equity that minimizes your cost of capital.
With this tradeoff on debt and equity in mind, let's turn to the data, and in particular, I plan to focus on the choices that companies made globally, on the financing question, in 2025. I will start by looking at the two forces that should have the greatest relevance in this decision, the tax benefits of debt and the default risk, and then look at the mixes of financing across sectors, industries and regions.
The Tax Landscape
Any discussion of taxes has to start with reality checks. The first is that governments need tax revenues, to fund their spending, and corporations and businesses are a target, partly because they affect taxpayers (and voters) indirectly, rather than directly (as is the case with income and sales taxes). The second is that businesses do not like to pay taxes, and try to minimize the taxes they pay, mostly through legal means, with accountants, transfer pricing specialists and tax lawyers abetting, though they sometimes step over the line into tax evasion. When measuring the tax burden that businesses face, we have to distinguish between three measures of tax rates:
Marginal Tax Rates: The marginal tax rate reflects the tax rate you face on the last dollar of your taxable income, and thus comes from the statutory tax code of the domicile that the business operates in. While there are a few companies that try to report these tax rates, you are more likely to uncover them by going into the tax code. Fortunately, the leading accounting firms keep updated estimates of these marginal tax rates in the public domain, as do some tax watchdogs, and I used The Tax Foundation for this year's updates across countries, and the numbers are in the picture below:
While your eye may be drawn to differences in corporate tax rates, across countries, these differences have narrowed, as the countries with the largest economies (and taxable business) are converging around a marginal tax rate of 25%. There are regional differences, with Latin America and Africa home to some of the highest corporate tax rates, and Eastern Europe and Russia home to some of the lowest. Clearly, there are exceptions within each region, with Ireland the leading outlier in Europe, with a marginal tax rate of 12%, and Paraguay in Latin America, with a marginal tax rate of 10%.
Effective tax rates: The effective tax rate is an accounting measure, reflecting the taxes paid and taxable income line items in the income statement, which follows accrual accounting principles. The effective and marginal tax rates can deviate for many reason, including corporate income earned in other countries, tax deferral strategies and even differences between tax and reporting books. I estimated effective tax rates for the companies in my database, and report the averages, by sub-region of the world, in the table below:
Corporate Marginal and Effective Tax Rates, by Country
In the aggregate, the effective tax rates were lower than the marginal tax rates in about 60% of the companies in my sample, and the difference is a rough proxy for the effectiveness of a tax system, with marginal tax rates running close to or behind effective tax rates in more effective tax regimes. By that measure, India has the least effective tax code among the regions, with an effective tax rate of 22.33% and a marginal tax rate of 30%, followed by the United States and Japan, though the caveat would foreign sales in lower tax locales, in each of these cases. The tax rate statistics, broken down by industry, for global companies, is at this link, if you are interested.
Cash tax rates: The cash tax rates also come from accounting statements, with the information in the statement of cash flows used to convert accrual taxes paid to cash taxes paid, and are reflective of what companies actually pay to governments during the course of the year. In 2025, the average cash tax rate across companies with taxable income was 25.86% (21.02%) for global (US) firms, about 1% higher than the effective tax rate in both cases.
For the debt question, it is the marginal tax rate that is most relevant, at least for computing tax benefits, since interest expenses save you taxes at the margin; interest expenses get deducted to get to taxable income, and it is the last dollars of taxable income that thus get protected from paying taxes.
The Default/Distress Landscape
In a world where companies never default, and you still get tax benefits from borrowing, companies push towards higher and higher debt ratios. In the real world, default acts as a brake on debt, with higher default risk translating into lower debt ratios. While default risk is company-specific, the exposure for default risk, across all companies, will vary over time, largely as a function of how well the economy is doing. The ratings agencies (Moody's, S&P and Fitch) track defaults on a year-to-year basis, and in 2025, they all recorded a drop in default rates across the globe, with US companies driving much of the decline. S&P, in its review of 2025 default and distress, reported that a drop in corporate defaults from 145 in 2024 to 117 to 2025, with the US share of defaults declining from 67% to 62%. To provide historical context, I looked at corporate default rates on loans (using data from FRED) on a quarterly basis going back to 1986:
While the low defaults in 2025 were a positive sign for lenders, especially given the economic turmoil created by tariffs and trade wars, there were some worrying trends as well. In May 2025, Moody's estimate of the probability of default at US companies spiked to 9.2%, its highest value since the 2008 crisis. On the bond ratings front, you had more ratings downgrades than upgrades during the year, and almost $60 billion in corporate bonds slipped below investment grade during the year. Breaking down all rated companies, by S&P ratings class, and by region, at the end of 2025:
Source: S&P Cap IQ
The US has the highest percentage of listed companies with bond ratings, but even in the US, only 11.43% of companies carry that rating, and that percentage is far lower in other parts of the world. Among rated companies, the US has the highest percentage of below investment-grade ratings, suggesting that in much of the rest of the world, there is a self-selection that occurs, where only companies that believe that they will get high ratings are willing to go through the ratings process. Finally, at the start of 2026, there are only AAA rated-companies left in the world, at least according to S&P, in Johnson & Johnson and Microsoft. Looking at 2025, through the lens of default, the numbers look comforting, at least on the surface, with the number of defaults decreasing, but there was disquiet below, as bond buyers wrestled with the consequences of a changing economic world order, and worries about another crisis lurking in the wings.
Debt Burden in 2025
With the background data on tax rates and default risk in place, I will turn to measuring the debt in publicly traded firms, in 2025, and differences in debt burdens across companies, sectors and regions. That mission requires clarity on how to measure debt burdens, and the picture below offers the choices:
Broadly speaking, debt burden metrics can capture debt comfort, i.e., the buffer that businesses have built in to meet their debt obligations and debt level, where you look at debt as a percent of overall funding. In the former group, there are two proxies that you can use to gauge the borrowing buffer - the interest coverage ratio, measuring how much companies have as operating income, relative to their interest expenses, and the debt as a multiple of EBITDA, capturing how many years it will take a company to pay off its debt, if current EBITDA is sustained. In the latter, I will look at debt as a percent of capital invested, using both accounting measures of capital invested (book value) and market value measures.
1. Debt comfort
When companies borrow money, the contractual claims from that debt usually take two forms. The first is interest expenses, and ongoing claim that gives you tax benefits but has to be covered out of income generated each year, and the second is repayment of principal, which comes due at maturity. The interest coverage ratio focuses entirely on the former, and interest payments are scaled to how much a company generates in operating income:
Interest coverage ratio = Earnings before interest and taxes/ Interest expenses
This ratio is simple, with high values associated with less default risk and more safety, at least from a lending perspective. It is still powerful, and it remains the financial ratio that best explains differences in bond ratings across non-financial service companies, and I use it to estimate synthetic bond ratings for firms in my corporate financial analysis.
The problem with interest coverage ratios is that they ignore the other contractual obligation that emerges from debt, which is principal payments due, and the ratio that is most often used to measure that exposure scales total debt at a firm to its earnings before interest, taxes and depreciation:
Debt to EBITDA = Total Debt/ EBITDA
With this ratio, lower values are associated with less default risk and more safety, because a firm, at least if it wanted to, could pay off its debt in fewer years with its operating cash flows.
In the table below, I look at interest coverage ratios and debt to EBITDA values, by sector, for US and global companies, using the same approach I employed in my last update and reporting a ratio based on aggregated values as well as the distribution of the ratio across companies:
As you can see, with both the US and global groupings, technology companies have the largest safety buffers when it comes to debt, with very high interest coverage ratios and low debt to EBITDA, whereas real estate and utilities have the least buffers, with low interest coverage ratios and high debt to EBITDA. As always, the contrast between the aggregated and median values indicate that larger companies, not surprisingly, operate with stronger buffers than smaller companies in almost every sector grouping. Finally, the debt comfort numbers are not computed for financial service companies, for the same reasons that we did not compute costs of and returns on capital for these firms - debt to a bank is raw material and not capital.
2. Debt level
If you go back to the financial balance sheet structure that I started this post with, the debt measure that emerges is one that scales it to the equity invested in the firm (debt to equity) and to the capital invested (debt to capital). These measures have resonance in corporate finance in valuation, because they become drivers of the costs of equity and debt and ingredients in the cost of capital.That said, you can measure this ratio using book value debt to capital (or equity), where you stay with the values of debt and equity reported on accounting balance sheets or with market value debt to capital (and equity ratios), where you use market values for debt and equity. At the risk of sounding dogmatic, book value debt ratios should never come into play in financial analysis and it is market value ratios that matter for two reasons. The first relates back to all of the criticisms I had of accounting invested capital in the context of computing account returns - it is dated and skewed by accounting contradictions and actions. The second is that it is unrelated to what you are trying to measure in a cost of capital, which is what it would cost you to acquire the firm today, where it is market price that determines how much you have to pay, not book value. That said, there remain a fairly large subset of analysts and firms who swear allegiance to book value for a variety of reasons, most of which have no basis in reality. I report book and market debt to capital ratios for all publicly traded firms, broken down by sector for global and US companies:
As you can see, companies look significantly more debt-laden with book value numbers than with market value, and in sectors like technology, where accountants fail to bring the biggest assets on to the books, the difference is even starker. The results in this table reinforce the findings in the debt comfort table, with technology companies carrying very little debt (3-5% in market cap terms) and utilities and real estate carrying the highest. I also reported, on the aggregated numbers, the gross and net debt ratios, with the latter netting cash holdings from debt.
In every data update post that I have written so far this year, AI has become a component of the discussion, reflecting the outsized role it played not just in market pricing during 2025, but also in business decisions made during the year. To see the connection between AI and debt, I will start with AI investing side, where hundreds of billions were spent by companies building AI infrastructure and large language models (LLMs) during 2025, with plans to spend more in the years to come. A sizable portion of this AI capital expenditure have come from big tech companies, with Meta, Alphabet, Amazon, Oracle and Microsoft all making large bets on the future of AI, and the extent of their investment is visible in the graph below, where I look at capital expenditures and cash acquisitions at these firms (with Broadcom added to the mix) from 2015 to 2025:
The shift at these firms from capital-light to capital-intensive models over this period has been staggering, with the collective investment in 2025 alone hitting $400 billion, with guidance suggesting that they are only getting started. It is worth noting that while big tech has garnered the AI cap ex headline, there are a whole host of other companies that are investing in AI architecture, which include real estate, data centers and power, and many of these companies are still not publicly listed. Going back to investment first principles, you can debate whether these companies can expect to generate positive net present value from their AI investments, and I have argued in earlier posts that it is very likely that they are collectively over investing, with over confidence and a fear of being left behind driving their both corporate investments and investor pricing, in keeping what you would expect when there is a big market delusion.
This big market delusion is a feature, not a bug, and we have seen it play out with dot com stocks in the 1990s, online advertising companies about ten years and even with cannabis stocks in the early years of their listing. The belief that the AI market will be huge, and have two or three big winners, is driving an investing frenzy not just at the big tech companies, but also in smaller start-ups and young firms, but the the market is not big enough to accommodate the expectations across all of these firms, and that will inevitably lead to a correction and clean up.
The AI investing boom enters the financing storyline, which is the focus for this post, because it needs immense amounts of capital. For many of the big tech companies, much of that capital has come from their existing businesses which are cash machines, although the AI cap ex will deplete the free cash flows available to return to shareholders. That said, though, the ramping up of capital investment has been so dramatic that even the cash-rich bit tech companies have turned to debt, as you can see in the graph below:
In 2025, the big tech companies collectively borrowed $160 billion, but given their cashflows and market capitalization, that debt does not put them at risk. For many of the smaller and lower-profile companies investing in this space, where internal cashflows are insufficient, there is a need for external capital, with some coming from equity and a significant portion coming from debt. It is in the context of the debt that I have to pick up on another storyline, which is the rise of private credit as an alternative to banks and the corporate bond market.
As you look at the explosive growth of private credit in this graph, it is worth emphasizing that private credit has been available as an option for borrowers for as long as borrowing has been around, but its usage explode in the last two decades. As AI has increasingly taken a starring role in markets, evidence is accumulating that more private debt is being directed to financing the AI investment boom,. With more than $200 billion in private debt going to AI firms in 2025, AI-related debt is rising as a percent of private credit portfolios.
As private credit has grown as an option, core questions remain of what it brings to a market as differentiating features that allow it to supplant more traditional lending alternatives, i.e. banking and the corporate bond market. Here are some of the reasons offered by private credit advocates for why it may be a preferred choice for entities, in general, and for those investing in AI architecture, in particular:
Better default risk assessments: One of the arguments that private credit lenders make is that they have the technical know-how to use data, that banks and bond markets have been more averse to using or have been constrained from using, to get better assessments of default risk. Those assessments, assuming that they are right, allows private credit to lend to entities at rates that are lower than they would be charged, with conventional risk assessments. In principle, that is a solid rationale, but I am unclear about what data it is that traditional lenders are not utilizing that private credit can use, but it is possible that technology and access to the internals of borrowing entities may provide an edge. In fact, the only way to gauge whether this argument of better credit assessment holds up is with a credit shock, where defaults spike across the board.
Cashflows-based versus Asset-based lending: A second argument is that traditional lenders, and especially banks, are focused too much on the value of the assets that they are lending against and too little on the cash flows. It is true that bank lending in particular is too focused on asset value, but that focus would provide an opening for private credit in AI, only if AI data centers and architecture investments are poised to start delivering large and positive cash flows soon, and banks are holding back on lending them money. I am hard pressed to think of too many AI investments that have these near-term payoffs.
Speedier and more Flexible/Customized Responses: IThis may be the biggest selling point for private credit in the AI investment world, where the investing entities are not just spending billions on AI architecture, but are in a hurry to do so. The regulatory and institutional constraints built into bank lending will stretch the process out in time, and issuing bonds, even if it were an option, comes with its own delay components. In addition, the debt for AI investments may need far more customization than what banks and bond markets can offer, or are allowed to offer, giving private credit an advantage. The problem with speed and customization being the biggest sales pitches for private credit is that it can go with taking short cuts on due diligence and adding terms to loans that cut against prudence, and those can be fatal to lending businesses.
Clearly, these reasons for the presence of private debt have merit, but only to a subset of borrowers, mostly smaller and private, and without a long borrowing history, and for a subset of projects. None that these reasons resonate for the larger tech companies, which have options to borrow money quickly and at fair market rates both from banks and the bond market, and Google's recent hundred year bond issue is an indication of how much slack bond markets are willing to concede to these firms. When a private credit fund lends Meta for an AI investment, as Blue Owl did in this transaction, the skeptic in me sees either a below-market-rate loan or one with terms that no prudent lender would accept in a loan, and neither is a sustainable lending strategy in the long term.
The coming together of the two storylines on AI and private credit comes with a risk that may extend well beyond the players in these spaces. If you agree with my contention that companies are collectively over investing in AI, driven by the big market delusion, there will be a time when that delusion dissipates and markets will have to correct. In an all or mostly-equity driven space, the pain will be borne by shareholders or owners of these companies, but while painful to them, its ripple effects will be limited. When debt enters the picture, as it has in the AI investment space, the effects of a correction will no longer be isolated to equity investors in these companies, and as private credit gets repriced (from the marking of debt down to reflect higher default risk), the pain to the rest of the economy increases. In effect, we will have a banking crisis created primarily by non-banking lenders behaving badly. We saw some of this start to happen in the last year, as the glow came off the AI rose, and S&P noted the stresses that it put on private credit players. Private credit has had a good run, in terms of delivering returns to investors in it, but it has, in my opinion, the relentless selling of it as an alternative investment class has made it much too big. A shakeout is overdue, which will separate the sloppy lenders from the good ones, and perhaps shrink private credit to healthier levels.
In every single year, from 1988 to 2025, the percentage of companies that pay the same dividends that they did in the previous year outnumbers companies that change dividends, and when dividends are changed, they are more likely to be increased than decreased.
