Takeovers, management buyouts and corporate restructuring are adding billions of dollars of debt to the balance sheets of the nation's best-known corporations.
Is this increase in debt a healthy phenomenon that is improving economic efficiency, or is it a recipe for disaster that will force many giant corporations to declare bankruptcy in the next recession?
The list of blue-chip corporations that now have hefty debt on their balance sheets includes CBS Inc., Unocal Corp., Revlon Inc., Phillips Petroleum Co. and Beatrice Cos. Inc. These companies all increased their debt significantly after becoming the target of unsolicited takeover bids.
Wall Street economist Henry Kaufman thinks this rising debt is dangerous because many giant enterprises may not be able to meet their future interest payments. But Harvard Business School Prof. Michael C. Jensen disagrees, believing instead that higher debt levels will force managers to operate more efficiently, producing benefits for the economy and signficantly increasing returns for stockholders.
"If our financial system becomes somewhat more fragile, it takes away some of the dynamism," Kaufman, a senior partner with Salomon Bros., said. "The least risk-taking occurs when you are heavily in debt. I don't think this problem is a problem that is going to become exceedingly acute in 1986. The problem will become exceedingly acute at the end of this economic expansion, when we go into the next recession.
"From a fundamental economic viewpoint, this [increase in debt] makes some businesses exceedingly financially vulnerable when we get into another recession. The next recession will test the resilience of these lower-quality entities that have been created, because their profit margins will be squeezed by large debt service interest payments on debt . Their capacity to service that debt will be doubtful."
"Anytime you have a recession, you have an increased level of bankruptcies and reorganizations," Harvard's Jensen said. "But there is no evidence of a problem anywhere in the system. What I see going on is the rational creation of debt in the takeover process. It is not without problems, and I wouldn't defend every single event that has occurred, but what I tend to see is high debt ratios created in situations that make sense.
"They are not being created in situations where companies are strapped, short of cash or have highly profitable growth opportunities," Jensen said. "Debt is being created in other places, bringing about forces in a complicated way to get cash out of the old, stodgy industries and into new high-growth areas."
In many of the giant takeovers of 1985, the acquiring company bought the target company's stock using mostly borrowed funds. In many corporate restructuring programs designed to enhance shareholder value and fight unwanted takeover bids, corporations bought back some of their own stock using borrowed funds.
Both cases illustrate the underlying trend: Debt is replacing equity, or stock, on corporate balance sheets at an increasingly rapid pace. Unlike stock dividend payments, which are optional, interest on debt must be paid, or a company has to reorganize financially.
Kaufman said that $113 billion of stock was retired through takeovers and stock buybacks in 1984, and an estimated $114 billion was retired in 1985, about 10 percent of all outstanding stock. In contrast, only $11 billion of stock was retired in 1980, $55 billion in 1981, $65 billion in 1982 and $38 billion in 1983, he said.
Kaufman said that while all of this stock was disappearing, corporate debt increased by a total of $360 billion in 1984 and 1985.
"I am deeply concerned about this" substitution of debt for equity, Kaufman said. "The abuse of credit and credit standards ultimately runs serious business risks, and if it gets severe enough, great political risks. And that we can't afford in a democratic society."