646  Capital Structure, Dividends, and Share Repurchases
Exhibit 33.7 shows the distribution of credit ratings and the associated av-
erage probability of default for all private and public companies worldwide 
with revenues in 2018 over €1 billion, according to Standard & Poor’s. The rat-
ings, which serve as indicators of a company’s credit quality, range between 
AAA (highest quality) and D (defaulted). Ratings of BBB– and higher indicate 
so-called investment-grade quality. A majority (60 percent) of the companies 
in Exhibit 33.7 are in the rating categories of A+ to BBB–; an even larger share 
(71 percent) fall in this range when we consider only companies with a mar-
ket capitalization over €5 billion. This is apparently an effective rating level: 
credit ratings are fairly stable over time, so most companies probably do not 
move in and out of this range. Few companies are at rating levels of AA– and 
higher, because too little leverage would leave too much value on the table 
in the form of tax savings and management discipline. At the other extreme, 
below the rating level of BBB–, the costs of business erosion and investor con-
flicts associated with high leverage become too onerous. At these ratings, the 
opportunities for debt funding are also much smaller, because many investors 
are barred from investing in sub-investment-grade debt.
Over the past decade, credit ratings for these large companies have de-
clined on average, shifting the distribution in Exhibit 33.7 to the right.23 In the 
United States, some experts and policy makers have expressed concerns about 
rising levels of corporate debt and deteriorating credit ratings.24 ­However, 
EXHIBIT 33.6  More to Lose Than to Gain from Capital Structure Management
0
5
10
15
25
20
25
40
50
60
100
125
200
225
400
Debt intensity,
% of optimal
Cost of under-/overleveraging,
% of firm value
Overleverage 
more costly than 
underleverage
Underlevered
Optimal leverage
Overlevered
Value impact
limited in wide
leverage range
Source: J. Van Binsbergen, J. Graham, and J. Yang, “The Cost of Debt,” Journal of Finance 65, no. 6 (2010).
23 See for example: “Carry the Weight: Should the World Worry about America’s Corporate-Debt 
Mountain?” The Economist, March 14, 2019, www.economist.com.
24 See for example, J. Cox, “Yellen and the Fed Are Afraid of a Corporate Debt Bubble, but Investors 
Still Aren’t,” CNBC, December 11, 2018, www.cnbc.com; N. Timiraos and A. Ackerman, “Fed Chair-
man Powell Warns of Economic Risks from Rising Business Debt,” Wall Street Journal, May 20, 2019, 
www.wsj.com.

SettinG a tarGet Capital StruCture 647
these trends do not necessarily mean that companies have taken on too much 
debt. The fraction of sub-investment-grade companies did indeed increase 
from 2008 to 2018, but this was driven not so much by downgrades of cor-
porations as it was by newly rated corporations that probably entered debt 
markets to benefi t from historically low interest rates. And while it is true that 
between 2008 and 2018, corporate debt in the United States grew from $2.3 
trillion to $5.2 trillion, key credit ratios are still similar to those of the prior 
ten-year period. 25 (Authors’ note: As this book went to press in March 2020, 
companies and governments were just beginning to assess and respond to the 
economic effects of the global COVID-19 pandemic.)
 To translate an investment-grade (AAA to BBB–) rating into a capital 
structure target for a company, you must understand what a company’s 
credit rating represents and what goes into determining it. Empirical evi-
dence shows that credit ratings are primarily related to two fi nancial indi-
cators. 26 The fi rst indicator is size in terms of sales or market capitalization. 
However, this indicator makes a difference only for very large or very small 
companies. For example, as of 2019, all industrial companies with AAA rat-
ings, such as Microsoft and Johnson & Johnson, have market capitalizations 
 EXHIBIT  33.7 Credit Ratings for Large Companies: Mostly between A+ and BBB–
% of companies sampled, by company size (revenues)
Investment-grade debt
Sub-investment-grade debt
Rating1
0 0
1 1
2 2
5
4
9
7
10
8
13
11
15
13
15
13
9 9
6
7
5
7
4
7
3
5
2
4
0
2
0 1
0 0 0 0
AAA AA+
AA
AA–
A+
A
A– BBB+ BBB BBB– BB+
BB
BB–
B+
B
B– CCC+ CCC 
Revenues > €5 billion 
(71% between A+ and BBB–)
CC
C
Revenues > €1 billion 
(60% between A+ and BBB–)
1 Standard & Poor’s credit ratings for all private and public companies with 2018 revenues exceeding €1 billion.
Source: S&P Capital IQ; Corporate Performance Analytics by McKinsey. 
 25 See T. Khurana, W. Rehm, and A. Srivastava, “Is a Leverage Reckoning Coming?” McKinsey on Fi-
nance , no. 70 (May 2019): 1–6.
 26 For an overview, see R. Cantor, “An Introduction to Recent Research on Credit Ratings,” Journal of 
Banking and Finance 28, no. 11 (2004): 2565–2573; E. Altman, “Financial Ratios, Discriminant Analysis, and 
the Prediction of Corporate Bankruptcy,” Journal of Finance 23, no. 4 (1968): 589–609; and J. Pettit, C. Fitt, 
S. Orlov, and A. Kalsekar, “The New World of Credit Ratings,” UBS research report (September 2004).