Rising interest rates alter the price of corporate debt and therefore change incentives for borrowing and investment. Michael C. Jensen at Harvard Business School and Stewart C. Myers at MIT Sloan School of Management theorized mechanisms in which higher financing costs raise the hurdle rate for new projects and magnify agency frictions that constrain investment. Empirical analyses from the Bank for International Settlements and the Board of Governors of the Federal Reserve System illustrate that when central banks tighten policy, corporate loan growth slows and interest coverage ratios tighten, making refinancing more expensive for highly leveraged firms.
Interest rate transmission to corporate finance
Higher policy rates feed into bank lending rates and bond yields, increasing both new borrowing costs and the carrying cost of existing floating-rate debt. Credit spreads tend to widen as lenders price in greater default risk, a pattern documented in analyses from the International Monetary Fund and the Bank for International Settlements that link monetary tightening to tightened credit conditions. Firms facing steeper service burdens re-evaluate long-term investments, postpone marginal capital expenditures, or reallocate available cash toward debt reduction, with cash flow-sensitive industries such as construction and heavy manufacturing experiencing pronounced adjustments.
Strategic responses and territorial variation
Corporate reactions vary by firm size, governance structure, and geography. Family-owned enterprises and firms in economies with shallow capital markets often rely more on internal funds, a resilience noted in research by Rafael La Porta at Harvard University, while publicly listed firms with market access can shift maturities or accelerate equity issuances where feasible. Territorial characteristics matter: export-oriented firms in small open economies may encounter exchange-rate and external funding pressures, and regional industrial clusters with high capital intensity face concentrated employment and supply-chain consequences that can reshape local communities and labor markets.
Longer-term impacts include re-prioritization of projects toward quicker payback and lower capital intensity, potential slowing of innovation-driven investment, and environmental implications when green infrastructure projects depend on low-cost, long-dated financing. Policy reports from the Organisation for Economic Co-operation and Development and the International Monetary Fund underline that transparent governance, diversified funding channels, and prudent balance-sheet management reduce vulnerability to rate cycles. Firms that adapt capital allocation rules and stress-test liquidity under higher-rate scenarios can better manage the trade-off between deleveraging and sustaining productive investment.
