Credit market conditions and the impact of access to the public debt market on corporate leverage

Abstract

This study examines the role played by credit ratings in explaining corporate capital structure choice during a period characterised by a major adverse loan supply shock. Recent literature has argued that supply-side factors are potentially as important as demand-side forces in determining corporate leverage. This is based on the premise that debt markets are segmented and that those firms that have access to the private debt markets do not necessarily have access to the public debt markets. The question of access to debt finance has become a major issue for public policy makers in several developed economies during the 2007–2009 financial crisis. The UK economy has been subjected to a period of severe tightening of credit market conditions resulting in a significant reduction in the availability of bank credit to the corporate sector. An important question is whether the contraction in the flow of bank credit to firms has affected firms equally or whether firms with access to alternative sources of debt finance have been able to mitigate the effect of adverse changes to the cost and availability of bank credit. To investigate this issue, this study employs data over a 20year period that includes two recessions and three noticeable periods of credit market tightening. Despite the fact that a severe recession has accompanied the 2007–2009 financial crisis we argue that the underlying forces driving the weakness in bank lending to the corporate sector are mainly supply side rather than demand side factors. In this study we use the possession of a credit rating as an indicator of access to the public debt markets. Our results provide support for the notion that having a rating is associated with higher leverage ratios, even after controlling for demand-side leverage determinants and macroeconomic conditions. More importantly, the study finds that the impact on leverage of having a credit rating varies over our sample period with the effect being greatest in those years when credit market conditions were tightest. The results are robust to the use of an alternative measure for public debt market access, different proxies for measuring the tightness of the credit markets, alternative econometric specifications and various sub-periods within our overall sample period.