Revenue Rise with Loans

While the choice of the most appropriate measure of corporate leverage is an arbitrary task, empirical studies indicate that the financing gap is able  to explain a lot of the variance in credit spreads. It is defined as the difference between capital expenditures, including outlays for inventories, and the amount of cash that corporations need to raise in order to finance their investment plans, expressed as a percentage of nominal GDP. The rapid rise in this metric was a powerful warning sign at the end of the 1990s that capital spending was overextended. As one usually observes at the end of recessions, the financing gap has not only closed after the 2001 recession, but fell substantially below its long-run average. In 2003, after-tax cash flow exceeded capital outlays, which is a rare occurrence. In the past, this was usually a good sign for capital spending. Intuitively, the US Treasury replaced the corporate sector as a financier for business spending.

Via tax cuts it provided the corporate sector with capital, thereby raising after-tax cash flow, and reducing the requirement for external financing through corporate debt issuance. The increasing amount of Treasury supply, combined with deleveraging in the corporate sector contributed significantly to corporate spread tightening between autumn 2002 and 2004.