Debt versus Equity : In a low interest rate environment

Abstract: Background: The long term downward trend in interest rates has brought us into new territory with negative interest rates. This should effect firms’ financing, and the choice between debt and equity. But how has the firms responded to the downward trend? Purpose: The purpose of this essay is to study the interest rate levels effect on decisions regarding capital structure. Existing theories give different answers when taking a lowered interest rate into account. The study aims to give empirical evidence from Swedish data. Methodology: By collecting financial data from 19 Swedish companies during 1998 until 2014, we will test the effect of the interest rate on the firms’ debt to equity ratio. This will be done by simple linear regressions. Conclusions: Our research show that our tested firms as a group decrease their debt to equity ratios when the cost of debt is lower. As we also show, debt has become cheaper relative the cost of equity, making the result even more noteworthy. Even though the results are in accordance with the Trade-off Theory, we argue that the theory needs to take more variables into account when determining financial distress.