Companies often reduce leverage during expansions because doing so strengthens resilience and preserves strategic optionality when credit conditions reverse. Research linking leverage cycles to amplified downturns underscores this behavior. Ben Bernanke at Princeton University, Mark Gertler at New York University, and Simon Gilchrist at Boston University describe a financial accelerator that makes high leverage costly in subsequent contractions. Hyun Song Shin at Princeton University and Tobias Adrian at the Federal Reserve Bank of New York document how procyclical risk models can drive leverage up in booms and force abrupt deleveraging later, creating incentives for firms to act preemptively.
Why firms deleverage in expansions
Firms face explicit regulatory and market signals encouraging lower leverage. The Basel Committee on Banking Supervision at the Bank for International Settlements designs regulatory capital buffers and countercyclical tools that make borrowing during tranquil periods less attractive for prudential reasons. Credit-rating agencies and institutional investors impose market discipline; Standard & Poor's Global Ratings and other major agencies link ratings to leverage metrics, affecting borrowing costs. Managers anticipating tighter regulation or higher future spreads may choose precautionary deleveraging to avoid covenant breaches, maintain access to capital markets, and stabilize funding costs.
Risks and consequences
Deleveraging in expansions reduces insolvency risk and improves shock absorption, but it also has trade-offs. Empirical frameworks developed by Bernanke Gertler and Gilchrist indicate that lower leverage can reduce return on equity and slow investment, potentially tempering growth or competitive expansion plans. Historical analyses by Carmen Reinhart at Harvard University and Kenneth Rogoff at Harvard University show that prolonged deleveraging episodes can be associated with weak aggregate demand and slower recoveries in some economies, especially where household or sovereign debt remains high.
Territorial and cultural factors shape choices: firms in emerging markets are often more sensitive to currency mismatches and therefore may deleverage earlier; firms in countries with strong stakeholder governance may prioritize stability over short-term returns. Policy tools from the Bank for International Settlements and research at the International Monetary Fund recommend countercyclical capital buffers and macroprudential measures to align private incentives with systemic resilience, reinforcing why many firms choose to deleverage while credit is plentiful.