Debt and Assets

Prior studies imply that a majority of US corporate debt by value is cash-flow based and only a small fraction of US debt is asset backed. Because corporations often prefer keeping assets unencumbered until creditors insist on security, much unsecured cash flow-based debt is also implicitly asset backed. Moreover, the degree of asset backing varies with a firm’s condition and the economic environment. Consequently, asset values affect both the amount and price of unsecured borrowing, with effects amplified in adverse conditions – consistent with financial accelerator theories. Because all corporate debt is supported both by future cash flows and asset values, with the relative support shifting with firm-specific and economy-wide conditions, the industry practice of classifying debt as “asset-based” or “cash flow-based” is overly categorical, especially for long term corporate bonds.