Debt/asset and debt/equity ratios should really be used in conjunction with interest support measurements, like times-interest-earned, to measure how leverage has changed. Unfortunately, that’s a level of detail not really feasible for a comment on a blog post.

Furthermore, the data I typically work with is firm-level data, but I’m simply talking in aggregates here. So, yes, on average firms’ leverage has gone down (albeit slightly), as cash holdings (among large firms) have increased. This appears to be in response to higher volatility of operating income. The tax regime hasn’t changed enough to reorder firms’ priorities.

Now, regarding the timing issue: this is important for individual firms. In an aggregate sense, I think the timing issue would tend to wash out, as assets and debt get replaced over time. So the trends in leverage should be reasonably accurate. The leverage (long-term debt/total assets) ratio tends to be 0.18 – 0.2, but the lowest one is 0 and the highest is around 1.3, so there is considerably cross-sectional differences.

Debt/asset and debt/equity ratios should really be used in conjunction with interest support measurements, like times-interest-earned, to measure how leverage has changed. Unfortunately, that’s a level of detail not really feasible for a comment on a blog post.

Furthermore, the data I typically work with is firm-level data, but I’m simply talking in aggregates here. So, yes, on average firms’ leverage has gone down (albeit slightly), as cash holdings (among large firms) have increased. This appears to be in response to higher volatility of operating income. The tax regime hasn’t changed enough to reorder firms’ priorities.

Now, regarding the timing issue: this is important for individual firms. In an aggregate sense, I think the timing issue would tend to wash out, as assets and debt get replaced over time. So the trends in leverage should be reasonably accurate. The leverage (long-term debt/total assets) ratio tends to be 0.18 – 0.2, but the lowest one is 0 and the highest is around 1.3, so there is considerably cross-sectional differences.

I’m not sure what that will tell you. As I see it, the distortion for debt ratios is caused by assets and debt on the books being acquired at different periods. If the book values of assets represent sums paid for those assets many years earlier – and the debt refers to debt acquired relatively recently – then the ratio of debt to assets is distorted. That has been exactly the case at large companies at which I’ve worked. Debt was extended to us not on the basis of the book value of assets but rather on the income producing ability of those assets, many of which were already fully depreciated.

I’m not sure what that will tell you. As I see it, the distortion for debt ratios is caused by assets and debt on the books being acquired at different periods. If the book values of assets represent sums paid for those assets many years earlier – and the debt refers to debt acquired relatively recently – then the ratio of debt to assets is distorted. That has been exactly the case at large companies at which I’ve worked. Debt was extended to us not on the basis of the book value of assets but rather on the income producing ability of those assets, many of which were already fully depreciated.

On the second point: I’m not sure where my head was at. It is obvious that lower denominators result in higher ratios. Thank you for pointing that out.

When I get a minute, I’ll deflate the total assets and long-term debt by the PPI (or would CPI be better?) and see what that tells us. Incidentally, did the Fed paper deflate market values by CPI or PPI?