By Peter Brierley of the Bank’s Financial Stability area and Philip Bunn of the Bank’s MacroPrudential Risks Division.
This article seeks to explain the high current level of UK corporate capital gearing. It also explores the empirical relationship between gearing and a range of financial characteristics. Analysis of aggregate data suggests that the sharp rise in gearing between 1999 and 2002 cannot all be explained by an increase in its long-run equilibrium level, according to a model where that equilibrium is determined by the trade-off between the tax benefits of debt and the risks of financial distress. There are a number of factors not captured by that model that could have contributed to a sustainable increase in gearing. But on balance it seems that gearing has been above a sustainable level, causing firms to adjust their balance sheets by paying lower dividends and issuing more equity and perhaps by investing less than they otherwise would have done. Analysis of company accounts data suggests that gearing levels are persistent, positively related to company size and negatively correlated with growth opportunities and the importance of intangible assets. In the past, highly profitable companies had low gearing, but this relationship has broken down since 1995 as more profitable firms have increased their debt.