EIB Working Papers 2018/03 – The corporate equity puzzle

Why don’t non-financial companies in Europe issue more equity? Using experimental data on firms from Europe, this paper analyses how firms trade-off between debt and external equity financing.
It finds that firms are willing to pay a substantial premium on debt when presented with an equity participation as an alternative. Companies are willing to pay an interest rate that is about 8.8pp higher than the cost of equity to obtain a loan instead of external equity.
This preference for debt can be explained only partially by the more favourable tax treatment of debt, fear of loss of corporate control and positive growth expectations.
This paper discusses what else may explain this striking aspect of firm behaviour in the EU.