The COVID-19 crisis and public debt
Modigliani and Miller’s theorem was one of the pillars of the modern financial economy. This theorem says that in an efficient market without taxes or bankruptcy costs, the market value and the capital cost of the companies are independent of the composition of their liabilities. This theorem has some assumptions of departure:
- The markets are perfect (informative and operational efficiency).
- Investors involved have rational behavior.
- There are no taxes
- The exploitation benefit is constant in time and the same for all.
- Companies are grouped with others of equal performance, so that the performance of all is proportional.
After the introduction of the theorem, I will continue explaining the different theoretical propositions next to the news.
Proposition 1 says that the market value and capital cost of the company are independent of the capital structure. Investors are interested when two companies with the same investment structures and different capital, and therefore since an arbitration opportunity is created and with it, to earn money. As we see in the news, investors seek to flee from the firms owed for fear of future insolvencies or debt restructuring and therefore, the devaluation of the shares towards companies without debts, using the arbitration technique. That is, they try to look for the same result that they could obtain in the indebted company, in a company without debt, looking for greater security against the debated debts without fear of future periods of illiquidity that would entail the collapse of the actions. Since in this period many companies from several different sectors have seen how their profits or income, which is what creates business liquidity, have seen how they have decreased and in some cases disappeared completely.
Proposition 2 says that the rate of return of an action is equivalent to the capitalization rate of the income flow of an unbreding company belonging to the same type of risk plus a premium due to the financial risk, which leaves the coefficient between the ratioof indebtedness due to the difference between the previous capitalization rate and the interest rate of the debt.
This can be summarized that the profitability that shareholders will require will be greater in a company with debt than in a debt without debt. The difference will be, the previously begged, risk premium. Basically this comes to say that shareholders who dare to invest in a company with debt and therefore greater risk, will be rewarded or demanded greater profitability. Spinning it with the news we see several companies, such as NMC Health and Norwegian Airlines, for example, which have a very high debt, caused by different reasons but debt. In the case of NMC Health it was caused by the concealment of real numbers and in Norwegian Airlines for normal causes. These two indebted companies will see how their shareholders will require greater profitability, of which they had previously to the appearance of all that debt to continue remaining as shareholders.
Proposition 3 says that the return rate required for investment projects is independent of the way investments are financed, that is, it is independent of the company’s capital structure. If companies use actions or debt to finance, it will influence the way in which the value will be divided between obligation and shareholders, but the amount of value is not influenced.
As a personal conclusion, I do not know to what extent the Modigliani and Miller theorems can help.) thing that does not happen in real life.
From the static theory of Trade-Off, do you consider that the response to the current economic crisis can be resolved by increasing public debt?
Trade-off theory is a financial theory that defends the existence of an optimal capital structure, that is, an optimal ratio of own capital and foreign capital or indebtedness, which allows maximizing the value of the company.
As we have seen in the news the indebtedness of certain companies is very high and due to the COVID-19 still a little more and, adding to this the lack of sale and therefore of billing of companies during this time, the benefits of exploitationThey will be reduced and in some cases it will not give to pay the obligation.
Responding more specifically to the question asked is a very difficult decision since the global crisis caused by COVID-19 has originated due to a new agent contrary to other crises such as that of crack 29 or the most recent of 2008. Experts say that this crisis should end when the activity will begin again, spring effect or V. Unlike that of 2008, which due to the reasons why it originated was going to need several years for this great family debt bubble, business, etc. disappearing and recovering the economy. On the other hand, this crisis has jumped when the benches were sanitized and the factor that has exploded the crisis has been an external factor to the system, which incumbent world health and for this, states have had to paralyze the economy, something never seen in thehistory.
From one of the largest management companies, Pimco, they have said that the manual to follow is unknown to get out of these crises also emphasized the difference of the most affected sectors between 2008 and the COVID-19 affecting the first mainly to thebanking and real estate sector and is also affecting the sectors of oil and technology, totally different sectors, totally different sectors.
All organisms, agree that depression must be avoided. For this, international governments and organizations the main thing they have done is to inject liquidity, including bank loans and tax paying delays. With this, unionstion does not agree since it does not believe that it is the best way, having the great public debt that there is and even thinks, that due to this increase in public debt, the types can rise. Unigstion believes that to overcome this crisis a substantial improvement will be needed in regard to the health and monetary health and monetary stimuli by the Government.
As a brief conclusion, I do not know if it is good or not, the issuance of public debt to face the COVID-19 crisis since neither the most expert people know it due to the novelty of this type of crisis. If there were more information and knowledge about the subject and there was a proposal that most experts believeThe great uncertainty there is and in the short term I cannot assure that the issuance of debt is a good option or not.
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