Firms with high leverage tend to have a higher percentage of debt versus firm value, and less cash on hand. These organizations often exist in industries where large capital purchases could be necessary – such as utility companies. These large purchases are often easier to finance with debt as well and, unlike with equity, investors are more likely to engage in activity since the organization is legally required to pay back debt (Berman & Knight, 2009). Additionally, tax breaks are available to companies with high debt ratios as their taxable income is reduced. Lower leverage organizations tend to have more cash on hand and no debt. They are typically starting out and promise profit in the future rather than high returns in the short-term. Organizations that have a significant return as a result of operations could exist this way and finance on equity for a while, but with increased growth, this could become less practical. If the firm is hoping to take on expensive projects or expansions, using debt as a financing strategy could be less expensive than using equity, and by increasing debt, they may have the opportunity to reduce the amount of taxes paid in a given year.
Berman, K., and Knight, J. When is Debt Good? Retrieved from: https://hbr.org/2009/07/when-is-debt-good
Maverick, J.B. Debt to Equity (D/E) Ratios for the Utilities Sector. (7 February 2019). Retrieved from: https://www.investopedia.com/ask/answers/070715/what-debtequity-ratio-typical-companies-utilities- sector.asp
Way, J. The Advantages of using Debt as a Capital Structure. (28 January 2019). Retrieved from: https://smallbusiness.chron.com/advantages-using-debt-capital-structure-22011.html
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