It鈥檚 no secret that privately held companies incur higher debt costs on the bond market than their聽publicly traded counterparts. At the end of the day, private firms pay about 1 percent more to聽publicly finance their debt and have a worse S&P 500 bond rating, according to a University of聽91吃瓜 study that tested some of the factors influencing these cost variations.
, an accountancy professor at the , and his co-authors identified several mechanisms that drive up costs for private firms that raise capital via public debt, including assumptions related to downside risk without easy access to the equity聽market and whether private equity ownership influence is at play.
Because private firms have no obligation to open up their books, comparing public and private聽firms has been challenging for researchers, Badertscher said. To control for this, his study聽focused on private firms that enter the public bond market. 鈥淚n the U.S., if you issue public debt,聽the SEC views you as a public company, just like a company that has equity,鈥� he explained. In聽other words, private firms are subject to the same Securities and Exchange Commission investor聽reporting and disclosure mandates as those owned by shareholders, giving researchers access to聽the same data sets for both types of firms.
鈥淚f the disclosure regimes were not the same, then it鈥檚 always going to be hard to answer that聽question of whether public and private firms are charged a different rate for their debt because you could say, 鈥榃ell, gosh, the public ones have so much more disclosure. I鈥檓 willing to lend to聽them at a better rate because I can see everything they鈥檙e doing,鈥欌�� he said. Because private firms have no obligation to open up their books, comparing public and private聽firms has been challenging for researchers, Badertscher said. To control for this, his study聽focused on private firms that enter the public bond market. 鈥淚n the U.S., if you issue public debt,聽the SEC views you as a public company, just like a company that has equity,鈥� he explained. In聽other words, private firms are subject to the same Securities and Exchange Commission investor聽reporting and disclosure mandates as those owned by shareholders, giving researchers access to聽the same data sets for both types of firms.
The researchers, who included Dan Givoly from Pennsylvania State University, Sharon Katz聽from INSEAD and Hanna Lee from the University of Maryland, examined 24 years of SEC-required financial disclosure statements from public and private companies that issued debt from聽1987 to 2010. Their paper,聽聽was published in earlier this year in Management Science.
They calculated the cost of public debt for private firms was about 100 basis points, or 1 percent,聽higher than for a similar public firm. 鈥淒epending on the level of debt that you have, that鈥檚 pretty significant,鈥� Badertscher said.
The study also found that private firms received lower S&P 500 bond ratings. Specifically,聽private firms had an average rating that was 0.273 lower than public firms on a scale from 1 to 21, with 1 corresponding to an AAA rating and 21 to a D ranking.
The researchers were able to demonstrate that having easier access to equity lowers a firm鈥檚 cost聽of debt and that financing constraints have a stronger impact on the cost of debt for private corporations compared with public firms. 鈥淗aving equity is kind of like having another way to聽raise more money,鈥� he said. In a crisis, the public firm could, in theory, go back to the market and get more equity.
Even having 鈥渄eep-pocketed owners鈥� did not completely offset the impact of limited access to聽the equity market for private companies, according to the study, which also found that the risk related to equity accessibility 鈥渋s particularly acute during recessions, as private owners are less聽likely to make cash injections while they are already tightening their belts.鈥�
The study also compared the private firms to one another and found variations in the cost of debt within the sample. Some of those differences, they found, could be attributed to private equity ownership in the company. More than two-thirds of the private firm sample were owned by private equity firms. 鈥淭he risk there is that they鈥檙e quite aggressive,鈥� Badertscher said. 鈥淭hey鈥檙e聽risk-seeking entities. They鈥檙e looking for high returns, the private equity firms.鈥�
Originally published by at on May 6.