It has been conventional wisdom that, whatever its troubling side effects, the aggressive use of financial leverage pays off in higher company values. Two decades of finance-based research, which the authors summarize here, qualify that wisdom substantially. Corporate and personal tax rates, which of course vary from situation to situation, significantly affect the attractiveness of […]
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A decade of high inflation has trapped many chief financial officers between severe financing needs and weakened balance sheets. The overall deterioration in corporate financial health has been stunning (see Exhibit I). Hard-pressed during the 1970s to supply inflation-mandated additions to working capital and to meet the increased cost of new plant and equipment, CFOs leveraged every new dollar of equity with some 3½ dollars of debt. Having piled so much new debt onto their balance sheets, they now face sharply higher interest payments as a percent of pre-tax profits. Worse, since much of that debt is short term, they also face volatile swings in interest rates and heightened refinancing risks.
A version of this article appeared in the July 1982 issue of Harvard Business Review.
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TP Mr. Piper is professor of corporate finance at the Harvard Business School. His many publications include a series of jointly authored studies of the investment strategies of large financial institutions under the inflationary conditions of the late 1970s. His most recent HBR article, “Is Your Stock Worth Its Market Price?” appeared in May–June 1981.
WW Mr. Weinhold divides his time between research at the Harvard Business School and management consulting on issues involving corporate strategy, industrial organization, and financial economics. He is coauthor with Malcolm Salter of Diversification Through Acquisition: Strategies for Creating Economic Value (Free Press, 1979) and two HBR articles.
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