In Reading 23 section 3.3.3, it says that companies in higher-inflation countries exhibit lower levels of financial leverage, rely more on equity financings, and have a shorter debt maturity.
But if inflation is high in the economy, isn’t it cheaper on the long run to issue debt with long maturities? Because that just means the real cost of debt is reduced when taking inflation into account, and this will increase my company’s value on the long term? Why would a company prefer equity if inflation is expected to be persistent?
Assuming interest rates and inflation are negatively correlated, maybe there is less demand from investors when interest rates are low? Also as an investor you’re not going to want fixed income when inflation is out of control.
Think about it from the investors standpoint, if there is high inflation they will demand a higher interest rate, and perhaps some other investor friendly features (example: convertible bonds). If the compnay does not offer higher rates they will not be able to sell the bonds (at par). Therefore, a company in a high inflation country will face a higher cost of debt than a company in a low inflation country, even if the two are equal as risky. Bonds are more negatively affected by inflation than stock, and so it makes sense for a company to use less debt and more equity in a high inflation environment.