Intangible Assets and Capital Structure

Abstract

With intangible assets representing at least one third of U.S. corporate assets and one half of annual investment, it is important to understand to what extent intangible assets support debt. Some characteristics of intangible assets, such as high valuation risk and poor collateralizability, can discourage debt financing. Yet, intangible assets can generate cash flows just as reliably as tangible assets and may therefore support debt like tangible assets do. The empirical capital structure research has struggled to quantify the effects of intangible assets on leverage because most intangible assets are not reflected in financial statements. We take advantage of a recent accounting rule change that has made it possible to observe market-based valuations of a large part of intangible assets that beforehand where largely unobservable. With this novel dataset, we find a strong positive relation between intangible assets and financial leverage. The strength of this relation depends on the type of firm. In firms with ample tangible assets, the tangible assets can support the desired debt and intangible assets do not affect leverage. In firms with limited tangible assets, intangible assets strongly affect leverage and are the primary support of debt. On a per dollar basis across all firms, intangible assets support roughly three quarters as much debt financing as tangible assets. We also observe that the type of debt financing differs for firms whose assets are predominantly intangible. Firms with higher proportions of intangible assets utilize more unsecured and convertible debt, debt types that fit an intangible asset base well.