Revisiting The Capital Structure: Ten Investor Questions for CFOs on Q4 2024 Earnings Calls on a Higher For Longer Rate Environment

Below are ten key questions institutional investors may pose to public companies regarding their capital structure in a “higher interest rates for longer” environment.

1. How are you managing your cost of capital given persistently higher interest rates?

Why This Matters: When rates rise, both the cost of debt and the required return on equity move higher. Maintaining a sustainable cost of capital becomes critical to safeguarding margins, funding growth, and preserving shareholder value.

Historical Precedent: During the early 1980s “Volcker Shock,” the Federal Reserve hiked rates above 15%. Companies with significant floating-rate debt or upcoming refinancing needs faced a sharp jump in interest expenses, underscoring the dangers of mismanaging borrowing costs in a rising-rate environment.

2. What is your optimal debt ratio now that borrowing costs have increased?

Why This Matters: A higher cost of debt raises the risk of financial distress, which can outweigh the tax benefits of additional leverage. Striking the right balance between debt and equity financing becomes a critical strategic decision.

Historical Precedent: In the leveraged buyout boom of the mid-to-late 1980s, some highly indebted companies struggled with elevated interest payments when rates climbed, leading to restructurings or bankruptcies. This period highlights the perils of over-leverage.

3. How do you anticipate your interest coverage ratios evolving, and what are the implications for credit ratings?

Why This Matters: Credit ratings influence the cost of future debt issuance and access to capital markets. If interest coverage ratios decline due to higher rates, credit rating agencies may downgrade a company’s debt, further pushing up borrowing costs.

Historical Precedent: In the aftermath of the 2007–2008 financial crisis, many companies saw credit downgrades when their interest coverage ratios deteriorated amid tighter credit conditions and declining revenues. Those that could not shore up coverage quickly found themselves in prolonged distress.

4. Have you reassessed the maturity profile of your debt to manage refinancing risk?

Why This Matters: Refinancing shorter-term debt in a high-rate environment can be costly and may strain liquidity. Extending maturities or staggering them can mitigate the impact of volatile credit markets and reduce the risk of a liquidity crunch.

Historical Precedent: In the late 1970s and early 1980s, firms with heavy short-term debt faced abrupt hikes in interest costs when rolling over obligations. The most stable companies often opted to lock in longer-term financing, even at somewhat higher fixed rates, to avoid crippling short-term spikes.

5. How do you plan to balance liquidity needs with growth investments under higher financing costs?

Why This Matters: Companies must ensure they have sufficient liquidity to weather economic or rate shocks while still pursuing growth opportunities that exceed their (now higher) cost of capital. Prioritizing projects becomes more critical when external funding is expensive.

Historical Precedent: During periods of tight monetary policy—such as in the early 1990s—firms that prudently allocated capital to their highest-return projects emerged stronger once rates stabilized. Others that spread resources too thin found themselves cash-strapped and unable to respond to competitive pressures.

6. Has the rise in interest rates prompted changes in capital return policy, such as dividends or share buybacks?

Why This Matters: When borrowing costs increase, the trade-off between returning capital to shareholders and retaining funds for investments or debt reduction becomes more pronounced. Maintaining overly generous dividends or buybacks can strain balance sheets in a high-rate world.

Historical Precedent: In the early 2000s tech bust, many companies paused or reduced share repurchases as profits fell and credit conditions tightened. Those that continued aggressive buybacks later found themselves heavily indebted just as markets turned volatile.

7. How will the higher cost of equity (driven by elevated market risk premiums) influence your capital structure decisions?

Why This Matters: As rates rise, investors often demand higher returns on equity, affecting share price and making equity issuances less appealing. Companies must recalibrate the mix between debt and equity while carefully considering dilution versus financial flexibility.

Historical Precedent: In the post–dot-com bear market of the early 2000s, equity valuations plummeted and the cost of equity soared. Some companies delayed equity raises to avoid excessive dilution, but others missed critical funding windows, stunting growth and innovation.

8. What stress-testing or scenario analyses have you conducted to ensure resilience under sustained high rates?

Why This Matters: Scenario planning helps gauge the potential impact of prolonged high rates on coverage ratios, covenants, and liquidity. Investors want to see that management has a game plan for downturns or additional rate hikes.

Historical Precedent: Post-financial crisis regulations emphasized stress-testing for banks; non-financial corporates similarly adopted more robust scenario analysis. Those that rigorously tested downside scenarios—like the automotive industry restructuring after 2008—made more informed capital structure choices and avoided liquidity crises.

9. Are you considering any asset sales, spinoffs, or restructuring to strengthen your balance sheet and lower leverage?

Why This Matters: Divesting non-core assets or restructuring can free up capital and reduce debt burdens. In a challenging rate climate, simplification of corporate structures can unlock value and enhance financial flexibility.

Historical Precedent: Conglomerates in the 1970s and 1980s often undertook spinoffs or asset sales when under pressure from high financing costs and activist investors. Examples include ITT’s dismantling of its diverse holdings, which improved the company’s focus and boosted liquidity.

10. How do you balance the trade-off between flexibility and the tax benefits of debt in this environment?

Why This Matters: While debt may still provide a tax shield, high interest rates reduce its net benefit and increase the risk of distress. Companies need to weigh the short-term advantages of leveraged financing against the long-term cost of reduced financial flexibility.

Historical Precedent: The 1980s leveraged buyout wave showcased the allure of tax shields but also illustrated the severe downside of inflexible capital structures when rates rose or business conditions deteriorated. Many LBOs ended in default or restructuring, emphasizing the importance of preserving flexibility.