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

Corporate debt is fundamentally just a piece of capital structure and tax arbitrage. It's not really something that is that concerning. Fundamentally, the overall value of a company is independent of how it is financed. You can sell some standard bonds, issue some of those senior to other ones, issue common and/or preferred stock, convertible bonds, whatever. End of the day there's assets and expected cash flows, and all the various tranches add up to the whole thing. So, why do companies like debt instead of equity? It has advantageous treatment in the tax code. If your company is financed entirely by equity and it earns $100M in profits, you get taxed on the full $100M. If you sell bonds that pay out $20M in interest each year, your taxable profits are now $80M instead of $100M. The people buying these corporate bonds are all fully aware that they behave like equity. Capital structure arbitrage firms will actually hedge their long or short corporate bond positions by taking offsetting equity positions - buy the bond, short the stock, and collect the excess yield. So it's not really any sort of moral thing with having lots of corporate debt out there, mostly just an anomaly in how claims on corporate assets are divvied up in order to end up paying less in taxes.

rmrfrmrf 7y ago
Wait... but bonds these days are usually issued to fund stock buybacks, which inflates the stock price. Why would you short the stock in that case?
- ThrustVectoring 7y ago
  You short the stock because it has price moves in the opposite direction of the bonds, so you can afford to buy more bonds without undue risk of losses. Like, the trade has several pieces: 1. Buy the corporate bond, getting the credit spread over equivalent treasuries 2. Short the same face value of stock, which gives you back the price of the bonds in case of bankruptcy. 3. Buy call options on the stock to close out your short position, costing you the option premium to go into the trade. Also, stock buybacks don't (or at least shouldn't) increase stock prices.
  - xbmcuser 7y ago
    It would increase stock price as this results in fewer stock owning larger part of the company. 10 stock for a billion valued company. It buys back 2 shares now the same company is owned by 8 share some of the value will come down as less cash reserves but if it is a company with growing revenue and profits the individual share price will go up.
    - ThrustVectoring 7y ago
      The decrease in cash reserves should exactly cancel out the decrease in outstanding shares. Buybacks still help corporate executives, though. They have stock options, and buybacks make the stock price more sensitive to profits (since the company is smaller because it has less cash on hand).
fallingfrog 7y ago
But if you have issued a lot of debt, does that not expose you to risk when the interest rate changes? Additionally, don’t you think it’s true that companies are issuing debt to buy back their own stock, which they then intentionally overpay for in order to drive up the stock price?
- ThrustVectoring 7y ago
  Interest rate risk isn't a huge deal for issuers when rates are this low - not much room for rates to fall. And even if it did become significant, the futures market has very effective tools for hedging various kinds of interest rate risk. >Additionally, don’t you think it’s true that companies are issuing debt to buy back their own stock, which they then intentionally overpay for in order to drive up the stock price? Stock buybacks are replacing dividends for tax reasons - they both make the overall value of publicly traded shares lower by giving cash to shareholders. Dividends trigger income tax by replacing share price with cash in hand, while buybacks reduce the publicly traded float at the same price and only triggers capital gains for the shareholders who wish to sell into the buyback.
  - fallingfrog 7y ago
    I was more referring to the risk of interest rates going up- would that not mean that the debt has to be either repaid or rolled over into a new loan at a higher rate, when it matures? What if the fed raises rates like it did during the volker shock- if you owe a lot of cash and the rates go that high, does your company not become insolvent?
    - reallydude 7y ago
      Only if the rates are adjustable. I'm not sure how common a financial advisor for a company would ok that, but I'll guess...almost never.
      - fallingfrog 7y ago
        Well they don’t have to be adjustable though right? I mean it doesn’t feel like this is debt that is ultimately being paid off, but rather just rolled over into new loans, on some schedule right? So when you roll it over, you might have to do so at a higher rate. I mean I’m not seeing companies go, ok we’re going to swap debt for equity here but then we’re going to pay all this debt off. The debt is permanent.

rmrfrmrf 7y ago

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

ThrustVectoring 7y ago
You short the stock because it has price moves in the opposite direction of the bonds, so you can afford to buy more bonds without undue risk of losses. Like, the trade has several pieces: 1. Buy the corporate bond, getting the credit spread over equivalent treasuries 2. Short the same face value of stock, which gives you back the price of the bonds in case of bankruptcy. 3. Buy call options on the stock to close out your short position, costing you the option premium to go into the trade. Also, stock buybacks don't (or at least shouldn't) increase stock prices.
- xbmcuser 7y ago
  It would increase stock price as this results in fewer stock owning larger part of the company. 10 stock for a billion valued company. It buys back 2 shares now the same company is owned by 8 share some of the value will come down as less cash reserves but if it is a company with growing revenue and profits the individual share price will go up.
  - ThrustVectoring 7y ago
    The decrease in cash reserves should exactly cancel out the decrease in outstanding shares. Buybacks still help corporate executives, though. They have stock options, and buybacks make the stock price more sensitive to profits (since the company is smaller because it has less cash on hand).

fallingfrog 7y ago

But if you have issued a lot of debt, does that not expose you to risk when the interest rate changes? Additionally, don’t you think it’s true that companies are issuing debt to buy back their own stock, which they then intentionally overpay for in order to drive up the stock price?

ThrustVectoring 7y ago
Interest rate risk isn't a huge deal for issuers when rates are this low - not much room for rates to fall. And even if it did become significant, the futures market has very effective tools for hedging various kinds of interest rate risk. >Additionally, don’t you think it’s true that companies are issuing debt to buy back their own stock, which they then intentionally overpay for in order to drive up the stock price? Stock buybacks are replacing dividends for tax reasons - they both make the overall value of publicly traded shares lower by giving cash to shareholders. Dividends trigger income tax by replacing share price with cash in hand, while buybacks reduce the publicly traded float at the same price and only triggers capital gains for the shareholders who wish to sell into the buyback.
- fallingfrog 7y ago
  I was more referring to the risk of interest rates going up- would that not mean that the debt has to be either repaid or rolled over into a new loan at a higher rate, when it matures? What if the fed raises rates like it did during the volker shock- if you owe a lot of cash and the rates go that high, does your company not become insolvent?
  - reallydude 7y ago
    Only if the rates are adjustable. I'm not sure how common a financial advisor for a company would ok that, but I'll guess...almost never.
    - fallingfrog 7y ago
      Well they don’t have to be adjustable though right? I mean it doesn’t feel like this is debt that is ultimately being paid off, but rather just rolled over into new loans, on some schedule right? So when you roll it over, you might have to do so at a higher rate. I mean I’m not seeing companies go, ok we’re going to swap debt for equity here but then we’re going to pay all this debt off. The debt is permanent.