Waiting for a friend in a downtown skyscraper the other day, I pulled a corporate finance text off her shelf to refresh my memory about why companies borrow money rather than allowing individual shareholders, if they want a higher-risk investment, to borrow money on their own and purchase shares with leverage. The book covered the Modigliani-Miller Theorem, a 1958 result showing that borrowing money doesn’t help a company’s managers or shareholders… in a world free of corporate taxes. Given a corporate income tax and deductible interest, however, a company can significantly improve its performance by borrowing.
The U.S. has some of the world’s highest corporate taxes (source) and we’ve also had a lot of leverage (Wikipedia says that private equity is more than twice as big in the U.S. than in Europe despite comparable economy sizes). The leverage made the Collapse of 2008-? a lot more painful than it would have been without the leverage (or maybe the collapse wouldn’t have happened at all).
Has anyone heard a public debate on this subject? I.e., whether or not our tax code substantially increases the risk of corporate bankruptcies by encouraging leverage?