Why corporations choose to use debt

Have you ever wondered why even the richest corporations have a good amount of debt and continue to to issue bonds and take out loans instead of trying everything to reduce their debt and be debt-free?

Well, this can have many reasons, the most important being the "leverage-effect", which will I be covering in another post because it is a huge topic.

The main reason why companies prefer debt is that debt is cheaper. But how and why?

One reason is what is known as a "tax shield." You pay less taxes as you can write off the interest payments of your debt, thus reducing the amount of tax you have to pay. So the cost of debt is reduced by the tax rate, while this is not possible with the cost of equity.

Another reason for debt being cheaper than equity is that lenders demand a smaller return than equity investors. The reason for this is that with equity comes greater risk. Payments to creditors are guaranteed in the form of interested payments while there is no such guarantee for equity investors; they only get what is left (residual income).

Equity also is much more volatile than debt is.

And while equity investors start to lose money as soon as the company's value goes down, creditors still have a claim on the principal and interest

Also, equity investors have no legal claim to the company's assets if it should go bankrupt. Creditors are preferred and can expect to get at least some of their money back.

Please note that I am not a financial advisor and just want to share my knowledge.