Interest rates, liquidity and the corporate financing decision throughout the business cycle: a European analysis

ABSTRACT

The global financial crisis has shown that money affects the real economy. This study examines the influence of the price and stock of money in the economy on capital structure throughout the business cycle during the last financial crisis, with particular focus on the roles of long- and short-term interest rates, spread rates, and liquidity as reflected in the supply and velocity of money. The results, for a panel of listed European firms, indicate the significant impact of these variables on leverage, which they find to be linked positively to long- and short-term interest rates and negatively to term spread in both phases (expansion and recession) of the business cycle. They also suggest that liquidity requirements play a crucial role in the corporate financing decision. Finally, the speed of adjustment to the target debt ratio, normally significantly lower during recessions than during expansions, appears subject to business cycle fluctuations.

KEYWORDS:

• Capital structure
• interest rates
• spread rates
• liquidity
• monetary policy
• business cycle

JEL CODES:

• G30
• G32
• D22
• C23

Acknowledgments

The authors are grateful to Carol Ann Wiles, the two anonymous referees for suggestions and comments on previous versions of the paper, Luis Pablo de la Horra, Jorge Gallud, Ana Martinez-Cañete and participants in the XXIX ACEDE Conference held in La Coruña (Spain). All the remaining errors are the authors’ sole responsibility.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. See, in this regard, Banco de España, Economic Bulletin, January 2013: The ECB’s unconventional monetary policy measures throughout the crisis.

2. Such programmes include the Covered Bonds Purchase (CBPP) or the Outright Monetary Transactions Programme (OMT), the European Financial Stability Facility (ESFF) and the European Financial Stability Mechanism (EFSM). In 2015, the Asset Purchase Programme (APP) was developed for the acquisition of sovereign bonds, securities issued by supranational European institutions, corporate bonds, asset-backed securities and covered bonds.

3. The yield on Spanish sovereign bonds was never higher than 7%, which was considered by analysts to be the red line above which debt is not placed on the financial markets, as happened in the cases of Greece, Ireland and Portugal, which had to be bailed out (Moody & Mackenzie, 2011).

4. Italian sovereign debt has a longer than usual maturity which makes the country more resilient to a financial shock (Schmieding et al., 2011).

5. Although data are available from 2002, the final sample period covers the period 2003–2013 since some of the variables used in our estimates are lagged.

6. The expected sign of the relationship between macroeconomic variables and leverage is described in section 2.

7. In 2009, the growth rates in GDP were −2.90% in France, −3.80% in Spain, −4.20% in the UK, −5.30% in Italy, and −5.70% in Germany (Data from OCDE and Eurostat, 2020).

8. UK and Italy had positive and negative growth during the different quarters of 2008 with a small and insignificant effect on unemployment (Data from OCDE and Eurostat, 2020).

9. Further interpretation of the coefficient, leading to similar conclusions, is omitted for the sake of brevity.

Additional information

Funding

This work was supported by Ministerio de Economía y Competitividad (Spain) [grant number ECO2017-84864-P].