1. Basic financial theory: Why is equity normally more expensive?
Under ordinary financial conditions, equity investors in the same firm bear more risk than lenders. In liquidation, creditors are paid before shareholders; interest and principal payments are contractual, whereas the return to shareholders is not guaranteed. The ranking expected in financial theory is therefore:
ke > kd
Here ke is the cost of equity and kd the cost of debt. Interest deductibility can reduce the after-tax cost of debt still further:
After-tax cost of debt = kd × (1 − T)
The statement that “debt is more expensive than equity” is therefore not a general rule; it is an exception. The exception observed in Türkiye is linked to abrupt changes in money and credit conditions that push the price of new debt up in a very short time.
2. Concrete episodes in Türkiye: Examples of extremely expensive debt
In Türkiye the episodes of 2018 and 2023–25 in particular are periods in which commercial-loan costs rose extraordinarily quickly and the ranking of debt and equity costs became, for some firms, open to debate.
| Period | Facts | Financial interpretation |
|---|---|---|
| 2018 tightening | Commercial-loan rates rose from about 17.9 percent to around 35 percent. | The cost of borrowing almost doubled in a very short time. |
| May 2024 | TL commercial-loan rates reached about 63.70 percent. | The spot cost of new TL debt reached a level that could exceed many firms’ long-term cost-of-capital assumptions. |
| May 2025 | Fixed-rate TL commercial loans of up to one year reached about 75 percent. | Short-term debt reached a level at which, even after the tax shield, it could become more expensive than equity for some firms. |
3. A concrete valuation example: Pre-tax debt cost exceeding the cost of equity
Direct examples of this phenomenon can be found in some IPO and valuation studies published in Türkiye. In a 2024 valuation study, for example, the cost of equity was taken as about 40.5 percent and the TL cost of debt as 42 percent.
ke = 40.5% and kd = 42%
In a pre-tax comparison the cost of debt then exceeds the cost of equity. If the tax shield can be used in full, however, at a 23 percent tax rate:
42% × (1 − 23%) = 32.34%
In this particular example, therefore, debt is more expensive than equity before tax but cheaper after tax. The result carries two warnings. First, the question “is debt more expensive than equity?” must be answered separately before and after tax. Second, whether the tax shield can actually be used must be tested.
4. Why has debt become more expensive than equity in Türkiye?
4.1. Inflation and exchange-rate pressure lead to monetary tightening; monetary tightening raises funding costs
In periods of high and persistent inflation and stronger exchange-rate pressure, the CBRT tries to restrain domestic demand, credit expansion and inflation expectations by raising the policy rate. The increase in the policy rate from 8.5 percent in June 2023 to 50 percent in March 2024 is one of the clearest examples of this mechanism. When the policy rate and deposit rates rise, banks’ cost of funds also rises. If a bank is paying high interest on deposits and other funding sources, it becomes economically difficult to extend long-term, low-rate TL loans to firms.
4.2. Higher funding costs and credit-supply constraints push commercial-loan rates still higher
Tight monetary policy can operate not only through the interest rate but also through the quantity and growth of credit. When credit-growth caps and macroprudential rules make banks’ capacity to lend scarcer, banks become more selective. In such an environment commissions, collateral, maturity and covenant terms can tighten as well as the interest rate. The firm’s true cost of debt is therefore not only the advertised rate.
Macroprudential regulations are rules used to limit risks that accumulate in the financial system as a whole. The aim is less the soundness of a single bank than the reduction of systemic risk that can arise when the banking system, firms and households are considered together.
In the simplest terms: monetary policy affects the price of money; macroprudential policy affects the quantity, direction and maturity of credit and the terms on which, and to whom, it is granted. If the CBRT raises the policy rate from 40 percent to 45 percent, that is monetary policy. If the BRSA says that a consumer loan above 250,000 lira may have a maturity of at most 12 months, that is macroprudential policy.
4.3. A slowing economy and the interest burden raise firm risk; higher firm risk raises credit spreads
The second component of the cost of debt is the firm’s credit risk. Higher interest rates raise financing expense; the interest-coverage ratio falls, cash flows weaken and the probability of default rises. The bank prices this new risk with a higher credit spread. The rise in interest rates therefore lifts not only the bank’s funding cost but also the firm’s risk premium.
4.4. Short-term debt carries refinancing risk: the economic cost of debt can exceed the coupon
That a substantial part of corporate finance in Türkiye is short-term makes the debt-versus-equity comparison still more critical. When a ten-year investment is financed with a one-year loan, the firm must roll the loan every year. A further rise in rates at maturity, or the bank’s refusal to renew the limit, produces refinancing risk. The economic cost of debt should therefore be viewed more broadly than interest, commission and tax. The annual percentage rate (APR) expresses, roughly, the total annual cost of the loan. (See: Pricing and Fund Management in Banking, 2nd edition, Chapter 3: The Strategic Framework of Loan Pricing and the Cost Structure.) The purpose of the APR is to make loans comparable by converting various credit costs into a single annual percentage rather than looking only at the nominal rate.
4.5. Incomplete use of the tax shield can make debt more expensive than it appears
One of the main advantages of debt is that interest expense reduces taxable income. If the firm is loss-making or does not generate a sufficient tax base, the present economic value of that shield falls. In Türkiye, moreover, the restriction on the deductibility of financing expenses can prevent part of those expenses from being deducted where foreign resources exceed equity. The classic kd × (1 − T) formula can then understate the true cost.
4.6. Spot loan rates and the long-term cost of equity price different time horizons
A short-term loan rate reflects today’s tight money conditions, whereas the cost of equity embeds longer-term expectations of growth, inflation, interest rates and risk. If the market does not expect today’s loan rates of 60–75 percent to remain at that level for several years, the short-term cost of debt can exceed the long-term cost of equity. The comparison should be made without ignoring differences in maturity and risk.
4.7. Excessive leverage raises the probability of default and spreads, and thus interest rates
As the firm’s leverage rises, the price of debt does not remain constant. When net debt/EBITDA rises, interest coverage falls or cash-flow volatility increases, banks demand a higher risk premium. Additional debt can then raise not only the cost of the new loan but also the rollover cost of existing debt. The mechanism is especially strong under tight credit conditions.
Annual percentage rate = loan interest + commission + cost of collateral + refinancing risk + liquidity risk + opportunity cost of contractual constraints
5. The self-reinforcing cycle of the cost of debt
In an economy such as Türkiye’s, where interest rates can change rapidly, the cost of debt can form a feedback process rather than a linear one: the policy rate and the cost of deposits rise; commercial-loan rates rise; the firm’s interest expense rises; interest coverage and cash flow weaken; the bank’s perceived default risk rises; the credit spread rises; the cost of new debt rises further. That cycle explains why the assumption that “debt is always cheaper than equity” does not hold, especially in periods of high inflation and tight monetary policy.
Türkiye’s experience shows that the proposition “debt is cheaper than equity” is true only under particular conditions. With moderate leverage, normal market rates, a sufficient tax base and low refinancing risk, debt is usually cheaper than equity. When high inflation, sharp monetary tightening, credit-supply constraints, high bank funding costs, a rising firm risk premium and a short-term debt structure come together, the marginal cost of new debt can rise very quickly.
The episodes of 2018 and 2023–25 in particular are strong examples of this mechanism in Türkiye. In those periods the pre-tax — and in some conditions even the after-tax — cost of new debt reached levels that could exceed the cost of equity in some firms.
The sounder principle in corporate finance is therefore this: “Debt is not always cheaper than equity. The right source of finance for the firm is the source that, under today’s conditions, keeps the after-tax and risk-adjusted marginal cost of an additional lira of capital at its lowest.”
A note to readers
When, using the CAPM, I found the cost of equity below the cost of debt, I too thought I had made a calculation error, and I found it hard to accept that this was in fact the case.
Financial theories offer general relations that hold under particular assumptions rather than universal and unconditional results; the empirical literature shows that those relations can differ substantially with the characteristics of the firm, the period, the country and the institutional setting.
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