SRW has argued that leveraged firms are less likely to lower prices as they need to make debt payments, and this can cause price stickiness.
I think this is a rabbit hole.
First, prices are not sticky — they just don’t respond to macro shocks in the way that simple models predict. That is a problem with the model, not with prices.
Second, whether a firm finances itself with debt or with equity, it must still meet its overall cost of capital. Firms are not more free to cut prices if they are financed with debt versus equity. In both cases, firms have committed in advance to deliver a certain operating margin, and if they are not able to meet this commitment, the management of the firm is replaced and/or the cost of financing for the firm is increased, up until the new, smaller firm *is* able to meet the margin demanded.
That is true regardless of how the firm is financed. The only difference is the mechanisms applied — bankruptcy + replacement of management versus replacement of management.
Let’s look at the data. I scraped Yahoo finance for the financials of the top 1200 firms for which there was a (north america) NAICS code.
Of that population, about 900 firms had a current 5 digit NAICS industry code producer price time-series tracked by the BLS on a monthly basis since at least 2007. Recall that producer prices are not the prices paid by producers, but the prices received byproducers for their output. The BLS receives over 100,000 price observations a month and tracks price indexes for up to 6 digit NAICS industry codes, which are rolled up into 5 digit codes, etc, finally being rolled up into the headline producer price index.
Of that population, about 800 were non-financial firms (e.g. everything except 52*).
Then, I compared the average firm financials for the trailing 3 year period with the standard deviation of the percent change in price index for the firm’s 5 digit NAICS industry code.
Firm financials were smoothed, i.e. the average leverage was the sum of the assets over the 3 year period divided by the sum of the equity over the 3 year period, to mitigate issues with equity volatility. The average long term debt to equity values were calculated the same way.
The results are zero correlation between the debt burden or leverage of a firm and the standard deviation of price changes for the firm’s products:
Here is the same data but with book value used in place of equity when calculating debt burdens and leverage burdens. Again, there is no relationship.
There is zero evidence for the leverage-price stickiness theory.
Capital is not free. Firms primarily financed with equity do not have more freedom to lower their markups than firms financed with debt.
Added the debt to book and assets to book graphs as well.