Debt and Assets

We examine the importance of corporate assets in supporting debt. Prior studies typically see only secured debt as asset backed, while the rest is deemed cash flow based. This implies only a small fraction of US debt is asset backed. Yet because corporations often resist offering security explicitly to debt, much unsecured debt is implicitly asset backed. Moreover, we find that the degree to which unsecured debt is asset backed can change with a firm’s condition and the economic situation. Consequently, asset values can affect the quantum and price of borrowing, with effects accentuated in adverse economic conditions, as suggested by financial accelerator theories. Given that a corporation’s debt is typically supported by both expected cash flows and assets, with the relative support varying with time and situation, the industry practice of classifying debt as “asset based” or “cash flow based” is overly categorical, especially for long term corporate bonds.